Make sure your savings leave you with more money than you started with...
Now, I am not talking about mattress-type savings. Or savings you make at your local bookmaker’s. What I am talking about is protecting your cash from inflation, which means that your money is worth less than it was.
Inflation is a measure of how much prices are going up over time, and details of the rate of inflation are published regularly. We have had really low interest rates for ages now, and lower interest rates normally means higher inflation...
Let’s say you want to buy some bacon. For the ease of calculation, and because we know how much you like bacon, let’s say the bacon costs £100 today in the shops.
Now, you know you will want to buy another £100 worth of bacon next year, so you stick £100 in a bog standard savings account paying interest at 2% per annum. This means next year you will have £102* to buy bacon with. Unfortunately inflation is currently running at 5.2% , which means that the same amount of bacon next year will cost £105.20. So you are £3.20 short of your bacon. And that cannot be A Good Thing.
So what can you do about it? Well, the simple answer is to invest in a savings account that is tied to the inflation rate and then you are guaranteed to have bacon money. We told you last month about the new index-linked National Savings Certificates, which are so attractive owing to their tax-free status, but some banks and building societies do offer inflation tracking accounts too. The downside is that they normally like you to tie your money up for a fixed amount of time.
Provided your rate at worst matches, and at best beats the Retail Prices Index (RPI) you will never be out of bacon. Make sure it is the RPI and not the CPI though- the RPI is a higher measure and will therefore deliver a higher rate of savings interest.
So why doesn’t everyone have an index-linked account? Well, aside from tying cash up (even assuming you have any), the interest rate you get is not guaranteed. Yes, the rate is normally a guaranteed percentage on inflation, but the rate of inflation itself cannot be predicted. Well, not accurately anyway. While inflation is relatively high, and interest rates are low, this type of account will be better for you. But if interest rates rise, as they surely will at some point, and/or if inflation falls, an index-linked deal may not be as attractive as it currently is.