05 Aug The Race to Beat Inflation
THE RACE TO BEAT INFLATION
With interest rates held at an historic low for 5 years, it’s not a great time for savers. Gone are the days where you could receive a healthy return on your capital from a regular savings account. The combination of low interest rates and rising inflation particularly affects those on a fixed income or who are dependent on their investments to supplement their income.
Inflation as of July 2014 stands at 1.9% (or 2.6% depending on whether you prefer the Consumer Price Index or Retail Price Index calculation), and interest rates are still just 0.5%. Instant access savings accounts, including NISA’s are not breaking any records, with returns of a between 2-3%. If you’re willing to lock away your money for 10 years, you can get just over 4% in a savings account – but given that it seems likely interest will start to rise over the next 18 months, locking that capital away may not be the best option.
Many investors have traditionally viewed cash as the safest option, and it can be useful to maintain a balance in an instant access account as emergency funds; but with interest rates this low, by leaving your money in a cash account, you’re risking erosion by inflation. You may get to keep the same figure in your bank account, but its spending power risks being reduced significantly and in real terms you’re losing money.
If you want to beat inflation, you’ll have to make your capital work harder; and that means accepting some risk. (Remember – you’re accepting some risk to your capital already simply by leaving your money in a savings account). Of course, the more risk you’re willing to accept, the higher the potential return.
Let’s take a look at some alternatives to cash, starting with the lowest risk option…
If you need a very low level of risk, you might want to consider National Savings and Investments. This stalwart of the investment community has been around since 1896, and now offers several investment options, from basic cash savings accounts to the famous Premium Bonds. The big draw of NS&I is that your capital is 100% guaranteed by HM Treasury- you can’t get much safer than that.
If you don’t need to regular income from your investments, you could consider the lottery of Premium Bonds. Although your capital is protected, this option does not pay out any interest to savers, instead the interest funds a monthly prize draw for tax-free prizes including two £1 million jackpots every month from 1 August 2014 – so of course you could potentially get a very good return! (But of course you might also just get back the amount you initially invested).
They also offer National Income Bonds which provide a regular monthly income. Currently at 1.2% gross interest, it’s nothing to write home about, but importantly it’s a variable rate, so when interest rates go up, the savings rate should rise too. You can also take out your money at any time.
Investors accustomed to cash may feel more comfortable with structured deposit products. A good alternative to cash, these products link returns to the performance of an index (e.g. the FTSE 100) but importantly they return capital IN FULL at the end of the specified term. They can also provide a regular income on certain products, if the index performs to target.
For example, currently the Investec FTSE 100 Target Income Deposit Plan 13 offers Annual payments of 4.5% per annum if the FTSE 100 is higher than 90% of its starting level on each Anniversary (subject to averaging). It also offers return of the initial deposit in full at the end of the 6 year term.
Because the annual payments are not guaranteed, this type of investment will suit those looking for a better return than cash provides, but are not reliant on regular income from their investment. You also need to be careful about making sure you understand all associated fees and tax liabilities when investing in such funds. It’s worth getting professional advice to make sure this is the right option for you.
Of course – what better example of a ‘real asset’ than bricks and mortar? Investing in the housing market has brought healthy returns in previous years, with house prices in England and Wales up 6.4% in July 2014 compared with a year ago. But of course, there is always the risk that the bubble will burst.
If you already have a residential mortgage on your own home, it may be that a Buy To Let property is your only option to invest in further property. Of course this brings with it up front and ongoing costs – as well as the hassle of becoming of a landlord!
If you like the idea of investing in property but don’t want to become a landlord, then property funds can provide an alternative. Bricks and mortar funds invest directly in actual commercial property, spreading the risk across a number of different assets – and can provide an annual return from rental incomes, as well as a potential increase in the value of your initial investment when you cash in the fund, if the value of the properties goes up over that term. It’s important to be sure this is a good choice for your particular circumstances, so make sure you take professional advice before investing.
Of course, as with investing in a single buy to let property, with bricks and mortar funds you are subject to vagaries of the housing market.
Equity Income Funds
Equity income funds can offer a much better potential return than cash deposits – but they can be volatile. Investors usually look at Equity Income Funds as a longer team investment- with the advantage that you’ll receive regular dividends without eating into your capital, plus the potential for capital appreciation. You could potentially be looking at a healthy return of more than 5% which in the current environment, even after tax and fees, beats available cash rates hands down, as well as receiving a regular dividend. This option can also prove tax efficient as it can be included in a NISA wrapper to limit your tax liability on interest paid.
Phil Jenkins, Independent Financial Advisor with Wren Sterling believes that equities can help investors get the best return. “In times of rising inflation, real assets such as equities and property can provide a better return than other options; investors do need to accept a certain level of risk, but this can be somewhat balanced out by diversifying their portfolio”.
Make the right choice for you…
As with any investment, you need to consider your attitude to risk and your requirements carefully before choosing where to put your capital. But it’s important to remember that despite a deeply held belief by most of us that cash is completely safe, with super low interest rates and rising inflation, the value of cash deposits will erode. You might need to be more imaginative to protect your capital, and more willing to accept a certain level of risk in return for an income from your investment. The best way to make sure you’re aware of all the options available, and the pros and cons of each, is to get independent financial advice, from an experienced advisor.
Please remember that the value of investments can go down as well as up and you may get back less than you originally invested.
This article is for information only and does not constitute advice – please make sure you get professional financial advice before investing.