Those of us with a bit of a clue would normally by now start to consider where next years ISA savings are going to live. Chances are the current interest rate you are receiving is about to drop drastically, as it was probably only a bonus anyway. Of course the ISA provider half hopes you’ll not bother and continue loading up the same one in the new tax year, whilst it offers a paltry 0.1% or so…
At around this time of year, too, the financial pages carry a range of adverts from providers detailing their new rates, and some papers and websites have handy comparison tables to make this a bit easier.
Well this year is no different – except for one tiny little detail. Thanks to a combination of factors the average interest rate being offered by providers is, well frankly, pathetic. Top rates of 2.0, or 2.5 might look attractive – especially if printed in a big enough typeface – but if you take inflation into account then they are in affect daylight robbery.
Inflation? What’s that? Let’s explain:-
Inflation* is a measure of how much prices rise – in affect a measure of the ‘cost of living’. A ‘basket’ of goods is used as an index, and the monthly average price is calculated**. The difference month on month is calculated as a percentage rate and reported as ‘the rate of inflation’. For simplicity’s sake this rate is actually assumed to apply to all goods and services, not just those featuring in the ‘basket’ and is taken as a measure of the cost of living***. The causes of inflation are many and complex, and beyond the remit of this post, suffice to say it happens and we have to deal with it.
How is this linked to savings? Well consider this heavily engineered and mildly preposterous example. Imagine a loaf of bread costs £1. You don’t need a loaf of bread this month, but you know you will next month. You also happen to have a pound in your pocket which you decide to put aside to buy a loaf next month. You put it in your piggy bank and forget about it. (Did I say this example was preposterous?)
Four weeks pass and you fancy some toast. You raid your piggy bank for that shiny £1 coin, go down to the shop, grab a loaf and go to the counter. ‘Just the loaf please’ you say. ‘That’ll be £1.03, please’ sayeth the shopkeeper. ‘Wha??’ you cry. It was a pound last month, you’re thruppence short. But in the intervening month inflation, conveniently set at 3% (maths is not my strong point), has pushed the price of loaves up.
Another way of looking at it is that your £1 no longer buys a £1′s worth of goods (in this case – again conveniently – only 97 pence worth of goods). Inflation has effectively devalued it, taken a chunk out of it’s value.
This is the major problem of holding cash as form of wealth. If it is taken out of circulation and just stuck somewhere, it withers and dies. Its important to realise that cash is just a medium of exchange, not really a measure or store of wealth in itself.
So how do you preserve the spending power of your cash. Well when you save it you ordinarily demand that it earns a rate of interest to compensate you for not spending it on something straight away. Knowing what you now know about inflation when you do come to spend it you want it to at least be worth the same as when you first stuffed it away. So you must also demand that that interest rate is at least equivalent to the rate of inflation to preserve the value of your savings for when you do want to spend it.
Er, where was I…?
Oh, yeah, ISA accounts, or at least Cash ISAs. We’ll assume you want to put your money away for the whole tax year and not withdraw it – you might even want to addnto it. When it comes to choosing next years provider you’ll want to prevent yournmoney dying as laboured above, so of course you need a rate that keeps up with inflation. Sources (as they are called) forecast inflation to remain somewhere around 2.7% for at least the next 12 months, so you need an ISA interest rate of at least that.
Guess what. No-one appears to be offering that at the moment. The closest for an ISA you can transfer previous years accumulated ISA savings into is 2.5%, so you’re still short. Many others offer no where near that rate.
One of the reasons mooted for the lack of offerings this year is that Bank andBuilding Societies have taken advantage of the Goverment’s money to lend scheme, which has provided vast amounts of cheap credit for the banks to lend to businesses and individuals. Because of that, they don’t need our money, which is why they offer savings schemes in the first place. In effect they borrow money from savers to loan to borrowers, and make a profit on the difference in interest they set for either side of the equation. In effect then the value of saver’s money has fallen – no one wants it – and so the savings rates offered are lower.
So where now?
It doesn’t look as if anyone is going to offer an inflation-proof savings scheme between now and the 6th April. In our household we have traditionally (well the last 4 years anyway – we’ve only just woken up to the Middle Class Con) used cash ISAs to shelter savings – specifically the interest earned on them – from tax. We have transferred accounts from one provider to another to get the best rate available (rate tarts they used to call people like that). The rates offered were sufficient to at least keep our cash ahead of inflation.
This year however we are given pause for thought. Leaving it in the cash ISA system at the moment will likely erode its value to us in the future. (We are using MarkyMark’s definition of savings as ‘deferred spending’ – more on this another time). But on the other hand once it leaves the cash ISA system it cannot be returned (above the annual deposit limit anyway) should interest rates become more attractive.
I guess the answer to the problem is what do we wnat the money for anyway. If it’s for a specific event in the not too distant future it would probably best leaving it a fairly liquid form, and therefore taking the hit on interest rates v. inflation.
The alternative is, if this money is just for some unspecified ‘rainy-day’ moment it might be better to put it into something more ‘investment-y’ to realise better potential returns. But that inevitably exposes us to ‘risk’, not a concept we have so far contemplated, at least not outside Barmouth amusement arcades! It also brings in the concept of management costs and fees which need to be factored in and their affect on returns and accessibility.
I’m gonna have to man up and do some homework here. I’ll keep you posted.
* originally economists defined ‘inflation’ as an increase in the (physical) money supply of an economy. It comes from when coinage – originally minted from a finite supply of precious metals, usually gold – was melted down and re-issued at the same face value but mixed with baser metals, in order to make the original gold supply go further. The physical value of the coin became debased and so merchants demanded more coins in exchange for the same goods and services.
** its actually far more complicated than that. Effectively an index value is calculated using a series of formulae based on the prices of that basket. The value on its own is of little value – at least to laymen like me. It’s the difference between indices across a period of time which is the crucial number.
*** there are actually several different indices or ‘baskets’ in use in modern economics, and at least 2 are used in UK politico-economics, depending on which one best serves the protagonist’s argument!!!