Four per cent – that's the figure to beat
In spite of the current state of the stock market, there are still ways for investors to better inflation, as Chiara Cavaglieri and Julian Knight report
Sunday 14 August 2011
You'd be forgiven for thinking your sock drawer is the safest place to hide your cash in the wake of the current stock market collapse.
But cash at home is hardly safe, and with inflation exceeding 4 per cent, any money not earning a good rate of return is actually losing value. So here are some options for your cash – some safer than others, some traditional choices, others more left-field – together with performance ratings of their likelihood to beat inflation.
Safety 10/10, performance 7/10
For many people, good old National Savings & Investments (NS&I) is the first port of call for safer savings, with a 100 per cent guarantee backed by the Treasury. The good news is that many of the products are top notch, with the index-linked savings certificates among the most popular savings accounts offering a very rare opportunity to beat inflation with tax-free returns. These certificates pay 0.5 per cent above the rise in the retail prices index (RPI) on maximum investments of £15,000 per saver, if held for at least five years. However, while inflation-proof savings are appealing now, there is no guarantee that they will offer a better overall return than a fixed-rate bond with a high street bank. NS&I also falls down on some of its other products, namely premium bonds, which are really just a punt on getting lucky.
"Premium bonds may be safe, but with the annual prize fund interest rate set at 1.5 per cent, unless you're very lucky, you'd be better off with a savings account," says Andrew Hagger of Moneynet. "The odds of winning (per £1 unit) are 24,000 to one."
Fixed-rate savings bonds and cash ISAs
Safety 9/10, performance 6/10
Returns of up to 4.75 per cent are available on long-term fixed-rate bonds, with Whiteaway Laidlaw Bank paying the top rate if you invest at least £5,000 for five years, but you still need to factor in the rising cost of goods and tax. And, if you want to tie up your money for only one year, the top bond from United National Bank pays a meagre 3.51 per cent.
"These accounts don't pay sufficiently to protect your savings from the impact of tax and inflation. You need a gross return of 5.25 per cent (or net return of 4.20 per cent) to maintain the spending power of your cash nest egg," says Mr Hagger.
If you haven't used up your allowance, the tax-free status of ISAs make them better performers than standard fixed-rate bonds – you can get a net return of 4.65 per cent with Birmingham Midshires for a five-year fixed-rate ISA – equivalent to 5.8 per cent gross for a basic rate taxpayer and 7.75 per cent for a 40 per cent taxpayer.
Bonds and ISAs are usually covered up to £85,000 by the Financial Services Compensation Scheme. However, this is limited to each authorised provider. So, if you have several accounts with one bank the protection limit is combined. To make things more difficult, some of the big names on the high street all come under the same institution, so if you have money with Halifax, Bank of Scotland and Birmingham Midshires, which are all part of the HBOS group, your cover for all those accounts will be limited to £85,000.
Gilts and corporate bonds
Safety 7/10, performance 7/10
Gilts and corporate bonds are a half-way house between holding cash in a bank or building society and shares. You can invest in gilts, bonds issued by the Government, via a stockbroker or directly from the Government's Debt Management Office (dmo. gov.uk). With UK corporate bond funds, such as M&G Corporate Bond and Fidelity Strategic Bond, you are investing in a form of debt issued by companies instead and these are only as safe as the company issuing them.
"For me, these have been the stars over the past week or so. They have shown what an important part they play in any well-diversified portfolio," says Jaskarn Pawar from independent financial adviser Investor Profile. However, he warns that there remains some uncertainty as to the long-term value of long-dated bonds and gilts, and prefers short-dated bonds and gilts, such as the Dimensional Global Short-Dated Bond fund, the iShares FTSE Gilts UK 0-5 and the iShares Markit iBoxx £ Corporate Bond 1-5.
Guaranteed equity bonds
Safety 5/10, performance 5/10
With guaranteed bonds and other structured products, you are offered fixed-term products that benefit from stock market exposure without having to put your capital at risk. So, if prices go up, you're quids in; and, if they go down, your original investment is safe – certainly an appealing notion right now.
The word "guarantee" is somewhat misleading when talking about these products, however, as some may keep their promise only if conditions are met – for example, if the FTSE 100 index doesn't fall by a certain amount. If markets fall and you do get your capital back, you lose money in real terms when you take inflation into account. Critics say that structured products are often overly complicated, relatively high risk and may offer disappointing returns because any growth excludes dividends. There are also harsh penalties for anyone who fails to see their plan through to the end. Even worse, the underlying assets may be held with an institution that is unstable and goes under, as with structured products that were linked to Lehman Brothers.
Absolute return funds
Safety 5/10, performance 6/10
By using hedging techniques, these funds are designed to produce positive returns in all market conditions. The sector saw a surge in popularity when stock markets collapsed. The funds use a complicated mixture of two investment strategies, the ability to go long and short, aiming to profit from falling markets.
Don't let the name fool you, though: an absolute return is not a cast-iron promise and several funds have failed to live up to expectations when put to the test. Backing the right fund manager is crucial. You will also need to fork out for annual fees as high as 2 per cent and a cut of any positive returns. "I worry about absolute return funds. I find them a strange offering. They basically try to guarantee relatively low returns for relatively high risk and relatively high cost. That's not a very attractive opportunity to me," says Mr Pawar.
Safety 4/10, performance 8/10
When markets are in trouble, commodities can be appealing because they do not necessarily depend on the financial position of companies and governments. Gold prices have soared, and investors are pouring money into exchange-traded funds as a cheap and easy way to gain exposure. Experts say that funds investing in gold-mining companies are looking undervalued and many recommend long-standing funds such as BlackRock Gold & General.
With a finite supply, the long-term investment prospect looks good. But because commodities and precious metals are so heavily traded, be prepared for volatility. It should make up only a small part of any portfolio. It also pays to remember that commodities will always be linked to the basic economics of supply and demand, so you will need to pick carefully.
"Commodities tend to do very poorly in contractions, or times of high risk aversion, due to the potential for lower industrial demand," says Nik Stanojevic, equity analyst at Brewin Dolphin. "Conversely, precious metals tend to do very well during these times and are frequently used by investors as 'portfolio insurance'."
Safety 4/10, performance 8/10
Investing in fine wines is hardly risk-free but with the benchmark index, the Live-ex 100, up 6.8 per cent on the year to date and 19.3 per cent year on year, the returns are difficult to argue with. With a broad mix of countries, including China, now buying heavily into wine, it shouldn't be dismissed as an alternative to the stock market.
"While we may see prices soften a degree this month, it's worth noting that wine shows a 15-plus per cent annual growth since 1990, and that returns have been generally stable," says Joe Marchant from Bordeaux Index.
The advice is to pick only reputable merchants and to stick with Bordeaux – the FTSE 100 of the wine world – for your first investments. Prices have risen sharply in wine in recent years and some suggest that this market has the hallmarks of a bubble.
Andrew Hagger, Moneynet
For the seasoned investor, a volatile stock market is often viewed as an opportunity to make greater medium- to long-term returns. But the huge daily swings we've witnessed over the past week would be too much for your average saver to stomach.
Savings rates from banks and building societies may be very low. However, it is the safety of capital that is paramount for many consumers. A rate of 3 per cent or so on your savings suddenly doesn't look so bad when you compare it with the losses some investors have suffered this month.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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