Falling returns in prospect for savers fighting inflation battle

A desire to have your savings earn their keep must be tempered by hard reality
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The Independent Online

inflation slipped downwards this week to 4.2 per cent. That should be good news for savers, as it means – in real terms – the value of their hard-earned cash is not eroded so quickly.

But with most savings accounts still languishing below the rate of inflation, keeping a nest-egg growing seems a harder task than ever.

Looking back five years, we can see how the low savings rate environment and relatively high inflation are really hitting home. According to figures from rates analysts Moneyfacts, £10,000 saved five years ago – earning an average interest rate – has a spending power today of just £9,402.

David Black, banking analyst at Defaqto, has crunched some numbers to work out how much interest rate savers need on a standard account to be able to achieve real returns above inflation.

The figures are astounding. A basic rate taxpayer – paying 20 per cent tax – needs to earn 5.25 per cent on savings to beat inflation.

The figures for higher-rate taxpayers are even more alarming. A 40 per cent taxpayer needs to earn interest at 7 per cent, while a 50 per cent taxpayer would need 8.4 per cent. There are no savings accounts on the market which pay anywhere near such targets.

"Just about everyone with a deposit-based savings account is losing money in real terms," warns Black. "Those relying on savings income to supplement their income, such as pensioners, continue to be hit really hard, as high inflation, coupled with the historically low base rate, impacts badly."

With economic uncertainty still rife and the latest financial news from Greece this week proving less than hopeful, moving cash into investments to get better returns also looks a risky strategy. So what can we now do to "inflation-proof" our money?

"There are few options for savers looking to protect their money from the effects of inflation," says Martin Bamford of advisers Informed Choice.

"They could tie savings up in index-linked certificates from NS&I, which guarantee a return of 0.5 per cent above RPI inflation when held for five years. But this is limited to £15,000 per issue and will not suit those savers who need – or want – instant access."

Bamford advises people to make maximum use of the tax-free returns offered through individual savings accounts. "Savers might also consider using some of their savings to make mortgage repayments, possibly using an offset mortgage so they could access their savings again in the future," he suggests. (See this week's Five Questions on page 56 for more on offset mortgages.)

David Black suggests: "To make the most of their money, people need to be proactive and regularly review their savings to see whether they can get a better deal elsewhere. There are some attractive deals available – such as introductory bonuses and guaranteed minimum rates – and people should seek to take advantage of these."

Danny Cox, of advisers Hargreaves Lansdown, also suggests NS&I's index-linked certificates, but says people should be looking to different investment opportunities for their only real chance to beat inflation. "NS&I index-linked certificates are still a good place for cash, since they are tax-free and guaranteed to beat the rate of inflation as measured by the RPI.

"Index-linked corporate bonds are riskier, but still a decent investment and funds like the M&G Index-Linked Corporate Bond fund are worth a look," says Cox. "Equity income is potentially an investment for all seasons and has historically faired very well against inflation, for those with the appetite for risk and a five-year time horizon."

Adrian Lowcock, senior investment adviser at Bestinvest believes investment is the only way to achieve better returns than inflation. "Within the UK, the equity income sector provides some protection against inflation, provided companies can pass on price rises to consumers and therefore maintain and increase their profits; paying more dividends," he says.

His pick in the sector is the Threadneedle UK Equity Income fund. But he also pinpoints inflation-linked bond funds, highlighting Fidelity's Global Inflation Linked Bond.

Looking abroad for returns can be risky, but investors worried about the potential contagion of Greek financial worries spreading in Europe could look further afield, Lowcock suggests. "Investors can access bonds in emerging markets and can benefit from better income yields than high yield bonds and the potential for currency appreciation – if it is issued in local currency," he says. He suggests Investec Emerging Market Local Debt as a fund offering access to this, but adds: "While we recommend investing in the region, we prefer more defensive funds, such as First State Asia Pacific Leaders."

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