Even though inflation has started to fall, the clamour for savings accounts which beat inflation has never been stronger. But whilst it’s important to beat inflation, is this the only thing savers should be taking into consideration when selecting a savings account?
Why is it important to beat inflation?
Simply put, if your savings don’t grow by an amount equal to inflation, the buying power will be reduced and you will lose money in real terms.
To put it another way. If at the start of a year you have £10,000 in savings account, paying an interest rate of 1% and inflation averages 3% over the next 12 months, whilst it might look as though you have made money, after all your statement will read £10,100. But you will have lost out in real terms, because £10,000 of goods will now cost £10,300.
What you could afford to buy at the start of the year is now unaffordable, because your savings haven’t kept pace with inflation.
Which accounts currently beat inflation?
First things first, what rate of interest do you need?
The Consumer Prices Index, or CPI for short, currently stands at 2.70%, so for a saver who doesn’t pay tax, or one who uses a Cash ISA (Individual Savings Account), this is all that’s needed.
However, for savers who pay tax the story is different:
- 20% taxpayers need a gross interest rate of 3.375%
- 40% taxpayers need 4.50%
- Whilst 45% taxpayers need a whopping 4.90%
The options are needless to say limited.
There are no accounts where a lump sum can be invested, which will allow basic or higher rate taxpayers to earn enough interest to beat inflation.
Non taxpayers can just beat inflation by using accounts from the Leeds Building Society, Secure Trust Bank and the Skipton Building Society. Whilst Cash ISA investors could use accounts again from the Leeds Building Society or First Direct; although the rate on this account is due to be cut shortly.
What do all these accounts have in common?
With the exception of the First Direct Cash ISA, which soon won’t beat inflation, all the accounts require you to tie up your savings for five years with no access to your cash in the meantime.
The price to beat inflation is therefore reduced flexibility, to get to your capital, take advantage of any future interest rate rises or change strategy if inflation rises above current levels.
Is the price to beat inflation worth paying?
Many people naturally assume that beating inflation is a good thing, and it is, but at the moment it comes at a price.
Five years is a long time to tie your savings and although the accounts will help some savers get a rel return now, savers also need to consider the effects of rises in inflation or interest rates.
Whilst the Bank of England’s ‘Forward Guidance’, would seem to indicate interest rates are unlikely to rise for another three years, we will see the end of the Funding for Lending scheme in early 2015 (unless of course it is renewed again). This could push up interest rates on savings accounts, as banks and building societies look to raise money to lend out. If you have tied up your savings for five years, you won’t be able to take advantage of any interest rate rises.
So, back to the original question: Is the price to beat inflation worth paying?
Our view is that whilst it’s always preferable to beat inflation, the price of doing so at the moment just isn’t worth paying.
We believe savers should consider shorter term fixed rates, perhaps for one or two years. This means accepting a real terms loss, but it gives flexibility to take advantage of potentially higher rates in the future.
Of course there is no guarantee savings interest rates will rise, they could still be in the doldrums in five years’ time. But we think this is unlikely.
Over the next few years flexibility is key.
Frustrated by low savings interest rates? There are other options
Of course savers could look to other options to try and improve returns. Clearly any investment which moves away from a savings account, perhaps to invest in stocks and shares or property, carries an increased level of risk to your initial capital, but it is one option open to savers.