Beat inflation with this savings account

The cost of living may be rising, but that doesn't mean your savings have to take the brunt.

Inflation is hitting all of us, hard. It hurts us when we spend money, but also when we attempt to save it too. But there are ways to beat it.

The rising cost of living

Inflation, very simply, refers to the increasing cost of living. There are two different measurements – the Retail Prices Index and the Consumer Prices Index, which use slightly different formula and look at slightly different things.

But whichever measurement you choose to use, the inflation picture has been pretty sticky for a while. In February, the Consumer Prices Index sat at 4.4%, more than double the Bank of England’s inflation target of 2%.

And while it has, somewhat surprisingly, fallen back to 4% in the last month (the first time inflation has fallen in eight long months), that’s still high enough that our money takes a hit. Not too many of us are sitting on 4% wage rises to help cope with the rising cost of living. Check out our How-to-beat inflation guide.

Savers bear the brunt

It’s not just how we spend our money that is affected by such steep inflation, but also how we save it. You may think you are being completely sensible, squirreling cash away, but if the rate of interest you’re earning on your cash after tax is not bigger than the rate of inflation, you are effectively still losing out.

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How to beat inflation

Inflation means that the cost of living is going up, and that your money doesn’t go quite so far. But there are ways to beat it.

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That means at the moment, savers need to have savings accounts paying in excess of 4% on their money, after tax. And there aren’t too many that do that.

Beating inflation

There is an easier way for savers to beat inflation, and that lies in the form of an index-linked bond.

Here’s how they work. You agree to put your money into the bond for a fairly lengthy period, generally three to five years. At the end of each year, the interest paid on your cash will be the rate of inflation plus a certain percentage. So no matter what happens with inflation, you will always earn a rate in excess of it.

So for example, with the Yorkshire Building Society’s Protected Capital Account, your cash is linked to the Retail Prices Index. This is undoubtedly a good thing for savers, as RPI tends to be higher than CPI, so you’ll enjoy an even better rate of return.

And the Yorkshire bond pays out the percentage increase in the level of RPI over the five year term, plus 1.50%. So even if inflation drops over the term, you're at least guaranteed a return of 1.50%.

With the Yorkshire bond there is an additional 0.50% bonus on your initial investment, so long as you hold the bond until maturity and your funds have been cleared by 26 April. So if you think the Protected Capital Account is the account for you, it pays to get a move on!

Of course, Yorkshire is not the only provider with this form of bond – Kent Building Society also has one paying RPI plus 0.39%, while other firms like the Post Office and BM Savings are also offering bonds which work in slightly different ways. It’s worth comparing each of them carefully to see which is best for your own circumstances.

Locking that cash up

However, before you run off to open an index-linked bond, there are a few potential downsides to consider.

In today's video, I'm going to highlight five things you should consider when choosing a savings account.

For starters, you’ll need to lock that cash up for a while, in most cases for five years. And that money really is locked up – if you try to close the bond early, you will be hit with some punishing exit fees. And because of the nature of a bond, by closing it early you may end up with less money than you invested in the first place.

So if you go for a bond like this, you have to be absolutely sure you can do without that money for five years. This needs to be cash that you’re highly unlikely to need to access – it’s no good using your emergency fund, as if that emergency pops up, you’ll be left out of pocket.

Outperforming the market

The other important thing to consider is whether the bond will give you a better return than you could get elsewhere. After all, it’s great that the bonds guarantee to pay out an inflation-beating rate over five years, but five years is a long time. It may be that inflation falls sharply in the next couple of years, and the rates on offer from savings accounts are far in excess of the inflationary figure.

So while the rate on the bond falls, by putting up with a year or two of loss-making on your savings, you could end up making more over the course of the five years by saving elsewhere as you’ll have the choice of an even better selection of deals a few years down the line.