March 2008
Whatever the current inflation rate is it's unfortunately impossible to protect cash savings from the full effects of inflation. This is simply because the Government says inflation is 4.2% but in reality it's at least 8% if not 10% or more for basic living expenses (food, petrol, electricity, petrol etc).
A simple text book solution to protect against inflation would be to buy inflation proof bonds such as those offered by National Savings & Investments (NS&I). But all of these bonds use the official RPI (Retail Price Index) currently 4.2% as their guide on how much to pay out.
And as all inflation proof bonds operate in the same way they are all going to offer only a partial hedge against inflation.
If you have cash savings and are worried about them being constantly eaten away by the menace of inflation then this guide will at least offer your funds the best protection available today, as well as suggesting some other strategies you might like to consider.
What About Buying Hard Assets
Hard assets, such as precious metals, property (physical or shares/funds) and commodities have traditionally always done well in times of high inflation. Buying them would therefore seem like a logical solution. However, the problem with hard assets is that they can always go down in value and many savers are unwilling to undertake price risks such as these.
How I Created A Semi-Inflation Proof Savings Portfolio
A family member, (Mrs X), asked for my advice concerning her £50,000 in cash savings as she was extremely concerned about the inflation threat. I am detailing below how I approached her problem and totally reorganised her savings plan.
Step 1 - Initial Audit
I first asked her to provide me with details of every financial account she had, including -
- Standard Bank accounts
- Savings accounts
- Pension accounts (she is over 60)
- ISA accounts - Both cash and stocks
- Details of any income
- Mortgages and any other loans
Once I received all of this information I entered it all into a simple spreadsheet. Basically her finances were a mess, with both large and small deposits in many different accounts, some of them paying 3% interest or less.
Step 2 - Surveying The Current Savings Market
To find the best savings accounts and bonds I didn't do anything special. Every paper has 'Best Buy' tables (the weekend broadsheets are normally the best) and in addition I scouted around some of the price comparison websites. I also checked Which!'s Best Buy tables as they are completely non-commercial and the ones I find the best.
It is very important when checking out different financial products, savings accounts and bonds to be on the lookout for the small print. As a general rule stay well clear of anything that looks complicated and you cannot instantly understand.
For example, many bank and savings accounts these days offer what at face value looks like fantastic interests rates, 10% or more. But this rate is normally only available on part of the savings, plus a minimum/maximum amount has to be deposited monthly and sometimes other non-competitive accounts have to be opened at the same time. Basically the accounts are pretty much all marketing fluff.
But accounts that pay bonus interest rates, perhaps an extra 1% for a year or more, are worth paying money into. But only if you're proactive enough (see Step 7 below) to change accounts if/when the account becomes uncompetitive.
Flexibility Is What We Want With Financial Products
I'm a strong believer that when it comes to money it really pays to go for the most flexible products available for the bulk of your money. Flexibility normally means money isn't tied up for long periods of time plus it is possible to transfer money without expensive penalties involved, such as losing 90 days of interest.
However, we should not automatically disregard any product which locks up our money for long periods of time because some of them are extremely good value, such as the Anglo Irish 1 year fixed bond listed below in Step 3.
Of course it all depends on how much money you have in savings. If less than £10,000 then I would always advise going with the most flexible account that pays a top interest rate. But if more than £10k in savings then it's fine to allocate up to 25% towards inflexible products that pay superior rates but at the same time lock up your money for 1 or more years.
After studying all the Best Buy tables I came up with the following savings accounts which are all extremely competitive at the time of writing (March 2008).
- Alliance & Leicester eSaver - 6.5% gross interest
- Coventry Building Society 50+ - 6.4% gross (only available to those aged 50 and over)
- Skipton Building Society Easter Bond - 6.54% gross fixed until Sep 2009
- NS& I 3 year Index Linked Certificate - 1.35% + current RPI (tax-free)
- Scarborough Building Society Direct Notice ISA - 6.3% (tax-free)
Step 3 - Savings Strategy
Now that I had the defined the best accounts I had to allocate the savings. Currently Mrs X has the following cash and accounts -
- £6,500 in Cash ISAs (earning around 5%)
- £7,000 on Stocks & Shares ISA (invested in a bond earning around 5.5%)
- £1,500 in Cambridge Building Society (earning around 3.5%)
- £35,000 in Barclays (earning around 3.9%)
Points to consider
- The cash ISA money will obviously stay due to its tax-free advantage
- The full Cash ISA allocation has been paid for the current tax year but £3,600 will be deposited after 6th April 2008
- The current ISA account will also be closed down and all the money moved to the Scarborough Building Society Direct Notice ISA
- The £7,000 already invested in the Stocks & Shares ISA will also stay and another £3,600 allocated after 6th April 2008. The present bond will be sold and new investments bought (see below for more details)
- The £1,500 in the Cambridge Building Society is currently earning a derisory 3.5% but this money is there as a potential ‘carpet bagging' payday if/when the Society gets sold so it stays
- The £35,000 in Barclays is definitely going to be moved and the account closed down
If the two ISA allowances of £3,600 are subtracted from £35,000 that gives a total of £27,200 to reinvest. I am going to split that four ways and invest £6,800 each into the following accounts -
- Alliance & Leicester eSaver - 6.5% gross interest
- Coventry Building Society 50+ - 6.4% gross
- Skipton Building Society Easter Bond - 6.5% gross (no access till Sep 2009)
- NS& I 3 year Index Linked Certificate - 1.35% + current RPI (tax-free but no access for 3 years)
There was no scientific reason behind allocating the cash to the different savings accounts above, rather the aim was to generally spread it around. If you wanted to keep it even simpler then instead of opening two similar accounts such as the Alliance & Leicester just open one but keep the amount of money invested in any one account to less than £35,000 which is the maximum insured amount applicable to all UK savings accounts.
It's Important To Explain Your Strategy
If you are helping someone to build a better and more productive savings strategy then it's important to talk through your plan with them.
Usually this involves explaining why their current strategy is not competitive as well as introducing the new savings accounts and products. Explain exactly how they work and pay special attention to those accounts where the money is tied up, ie both the one year fixed bond and the NS& I certificates. Make sure the person fully understands that the money in these accounts cannot be touched for the term.
If they are not happy with these kinds of restrictions then do not force them, instead allocate all the money to 100% instant access accounts.
Step 4 - New Account Openings & Closings
Now that we know in which accounts the savings are to be deposited it's time to open the new accounts as well as close down some of the present ones.
Contrary to general thought the opening of new bank accounts is pretty easy these days but I've found that in order for it to be as simple as possible it hinges on one thing - Are you on the electoral roll?
If so, the majority of banks will just cross reference your name and address (from say your driving licence) and sign you up immediately. But if you're not on the Electoral roll then opening a new account maybe slightly more laborious. If you're not presently on the electoral roll, contact your local council and note that being registered does not mean you have to vote.
If you are signing up online for an account paperwork often needs to be sent in, perhaps proof of address etc so allow a full 2 weeks before it's opened and money can be deposited. To close an account simply contact your bank either by telephone or letter.
Step 5 - Getting Online Banking Access (if available)
I am a massive fan of internet banking, in fact it's really difficult to keep 100% on top of your finances if you don't have it.
Forget about all the online banking security scares because the banks currently invest millions in anti-fraud measures. Sure, you're always going to read scare stories in the media (scare stories are usually their speciality these days) but if you're sensible about accessing your account online, ie keep control of your login information, there really is little if any risk.
In fact, even if you do find your account comprised the bank, assuming it's satisfied that there was no negligence on your part (ie you let somebody know your username/login information or PIN) all your losses will be covered.
I know several people who have experienced fraud with their credit cards when abroad and all of them have been compensated for their losses in full with no fuss.
Internet banking also makes it really easy and efficient to effortlessly transfer money from one account to another and that's important these days where if you want the best interest rates you have to be ready to move your money.
To summarise, if you aren't using internet banking you're missing out.
Step 6 - Transferring The Money
Now that the accounts have been opened it's time to transfer the money. As £7,200 was needed to be moved into ISA accounts (£3,600 each) after 6th April 2008 that amount was left in the Barclays account to be transferred later.
The rest of the money was moved from the Barclays deposit account to a Barclays current account to be either transferred out using internet banking or cheques written in the case of the 1 year fixed bond and the NS&I certificates.
Step 7 - Advice on Running The Savings Portfolio
With any savings account, or collection of accounts in this case, it's not so much a case of running the account(s) as the money will just be sitting there earning interest. But it is important to review the overall savings strategy and I would do this every 4-6 months. Right now the personal finance industry moves at a fast pace, new products are always being introduced and often come with very attractive terms.
Personally I wouldn't advise always chasing the best deals, perhaps your money is earning 6.5% and another bank offers an account paying 6.6%. Transferring money to earn an extra 0.1% is not really worth it but 0.5% or more in interest should definitely be of interest you.
Keeping track of the current market place is easy, just make sure you check the newspapers for the current Best Buys every few months.
Keeping Good Paperwork
It is also very important to keep good paperwork. One way to do this is to use 'batching', ie don't spend 5 minutes here and there sorting out statements and the like. Just dump all your paperwork and banking mail in one place and then spend 20-30 minutes every month opening, sorting and checking on the balances of your accounts.
If you do have lots of different username/passwords for internet banking then keep a small notebook handy where you write down all your login details. And if you're scared someone might find these details just use some sort of code for your passwords. For example if your password is cambridge99 write c99 as a hint in your notebook.
Step 8 - Investment In Stocks & Shares ISAs
Many savers simply don't like stocks or any similar assets because although they have the potential to offer a better return than cash they subsequently have the potential to lose value as well. And right now with the global economy most probably in recession and stocks looking shaky investing in this asset class is a cause for some concern.
Investing in these assets however does depend on a few factors such as how much money you have and your risk profile. For example, Mrs X has around £50k in liquid assets plus she has no debt and her monthly outgoings are affordable. Therefore investing up to 10% to 20% in stocks is not such a bad idea especially as she can afford to take a somewhat long term view.
The trick is of course to invest in the right stockmarket assets. Although I generally favour Gold thinking it has real potential to move to $1,650 or higher (currently around $970) I am suggesting to Mrs X only to buy if the price of Gold weakens to around $800-$850 over the coming months.
She already has around £7,000 invested in a Stocks & Shares ISA with another £3,600 to be added after 6th April 2008 (the next tax-year). I have advised her to buy up to £4,000 in Gold Sovereigns from www.atsbullion.com in London should the price of Gold move lower.
For the balance of around £6,000 I really like Macquarie Global Infrastructure Securities Fund. As its name suggests it invests in infrastructure and similar assets (airports, construction, ports, wireless networks, wind farms and utilities etc). I also believe that investing in infrastructure will offer a pretty good hedge against further inflation risk over the coming years.
Please note, that the goal of this investment is obviously to make money, but over a period of several years. The stockmarkets are notoriously volatile at present and look like staying that way so wild swings in stock prices are to be expected. Do not invest in the stockmarket unless you are comfortable with both the risks and the potential that your investments may well go down in value.
Summary
Using the above strategy for the cash savings I managed to squeeze at least an extra 2% in interest per year so the majority of the money is now receiving at least 6.5%.
A yield of 6.5% will go a long way in helping to shield against inflation. But as I said in the beginning it's just not possible to create an inflation-proof savings account at the moment so damage limitation is really the name of the game.
Useful Links
Another Anti-Inflation Strategy
By far the simplest anti inflation strategy right now is to reduce and slash your current spending across the board.
Like £10 bottles of wine, then go for the £7 ones instead. Like to buy the latest fashions, be on the lookout for special offers as well as checking on the internet to see if prices are cheaper. In fact, with the general High Street likely to be suffocating from a lack of sales this year look for some great price reductions overall (apart unfortunately from general foodstuffs).
The anti-inflation trick to saving money though is not the actual savings but what you do with the money. For example, it might sound slightly pedantic but I know one person who is not only an ace money saver but combines the money saving with investment. He takes note of everything he saves and then deposits 50% of the saving in a separate high paying savings account.
For example, say on a weekly shop he saves £15 by a combination of buying special offers and final markdown products. He'll then deposit 50% or £7.50 in the savings account. The trick to making this all work is internet banking where small amounts of money can easily and freely be transferred from a current account to a deposit account.
This strength of this style of money saving lies in its motivation. If you or I save £5, £10 or even £500 we often have nothing to show for it because the saved money sloshes around in our current accounts or pockets.
But if you diligently keep a specialist deposit account at the end of the year it's surprising just how much money can be accumulated. So the double bonus is firstly the cash but second the realisation that your money saving efforts are really paying dividends and that creates the motivation to keep the strategy going.
