Why risk leaving the safety of deposit accounts?
Many people are put off investment because of emotional fears about losing their hard earned savings. Yet they run even greater risks of losing out.
Your money is only worth what it does for you. If it sits in an account with a low interest rate for long enough you run the risk of losing out because of inflation. But inflation is zero so, surely, there is nothing to worry about?
The consumer price index (CPI) is currently at zero, but for how long? All measures of inflation are flawed. They measure a basket of goods and services which it is believed will represent how prices are rising (or falling). If you are spending your money on things that are not represented by that basket then your experience of inflation will be different.
Elderly people tend to spend a higher proportion of their income on utilities, gas and electricity; when energy prices rise it has a disproportionate effect on their personal inflation experience. Inflation is measured by looking at prices over the last twelve months so a big increase or decrease in prices will have an effect for the next year. This is particularly important at the moment as we approach the anniversary of the drop in oil prices in the fourth quarter of 2014.
Zero inflation can bring its own problems for future inflation. With pay rises in the order of 2.9% a year (Source: ONS), and no inflation, we are seeing real wages rise at a relatively high level. Higher real wages lead people to spend more and that in turn pushes up prices.
At the end of last year the Bank of England forecast a consensus view which suggested that we would see inflation at or near zero in the summer of this year; it was right. That same forecast predicted inflation creeping above 2% in the summer of next year.
What does 2% inflation mean for you? That depends on the return you get from your savings.
The best cash Individual Savings Accounts (ISA) rates are currently 2% a year, so you will at least see your money hold its value. If you are not invested in a top paying cash ISA you will be losing money.
For example RBS instant saver is paying 0.75% gross a year if you deposit at least £50,000; after tax at basic rate you would receive 0.60% a year. That’s a loss of 1.4% over twelve months.
You might feel that is an acceptable price to pay for avoiding bigger losses on the stock market. After all the FTSE 100 is down 6.71% from the start of the year (Source Yahoo: Finance 22-9-15). Over the long term it would be expected that share prices will improve but cash returns usually struggle to keep pace with inflation.
As we are all living longer this should be something that worries us all. In 1980, according to the Office for National Statistics, men were expected to live till they were 70 (76 for women) but by 2010 that had risen to 76 (82 for women). The longer we live the worse the impact of inflation. Over six years inflation at 2% a year means a sum of £10,000 needs to grow to £11,261 just to maintain its value. If you are receiving 0.60% a year on your savings you would have £10,365, a loss of £896 or nearly 9% on what is considered by many to be a safe investment.
What can you do? Accept that you need to take a slightly higher with your savings and invest in assets that have the opportunity to outperform inflation and cash returns.
This requires a deeper understanding of the way investments perform and why they go up and down, it requires you to educate yourself or seek financial advice from a good financial adviser.
> > Richard Leeson is Senior Money Writer for Daily Business and the author of How And Why To Invest, Making Your Money Make You Money available on Kindle for £4.03 at http://amzn.to/1dga4iS