With the official rate of inflation (rising prices) hitting an all-time high, the higher cost of living is hitting our savings hard. Here's a powerful way to fight back.
This article was first sent to Fools as a standalone email in out 'The Good, The Bad and The Ugly' series.
Alas, here's more bad news for Britain: the cost of living has risen significantly over the past year. According to the latest figures from the UK Statistics Authority, the Consumer Prices Index (CPI) measure of inflation rose to an all-time high of 4.7% in August, versus 4.4% in July. In other words, goods and services costing £100 in August 2007 now cost £104.70. Ouch!
The government's target for CPI is 2%, so this news means that -- for the second time this year -- the Governor of the Bank of England has had to write to the Chancellor, explaining why CPI is more than 1% above this target. What's more, this latest news means that cuts to the Bank of England base rate are unlikely until inflation starts to weaken.
Another measure of inflation, the Retail Prices Index (RPI) is up 4.8% on the year, compared to 5% in July. I prefer the RPI to the CPI, largely because the CPI excludes mortgage costs and is therefore not a useful measure for nearly half of all households. For the record, the rise in inflation has partly been fuelled by steeply higher food and energy bills.
Inflation is the enemy of savers
Of course, higher prices hit all of us in the pocket, but pensioners and those on fixed or modestly rising incomes suffer the most pain. Furthermore, because inflation erodes the future value of money, it has a negative impact on your savings. For example, the following table shows how much the savings of different taxpayer groups would have to earn in order to keep pace with RPI inflation at 4.8% a year:
Tax band | Yearly interest rate before tax (%) |
|---|---|
Non-taxpayer | 4.8 |
Basic-rate (20%) taxpayer | 6.0 |
Higher-rate (40%) taxpayer | 8.0 |
As you can see, the savings of basic-rate taxpayers have to earn 6% a year before tax in order to match inflation at 4.8%. For higher-rate taxpayers, this savings-rate hurdle is even higher: 8% a year. Although we Brits can choose from thousands of different savings accounts, I know that no everyday account pays a yearly interest rate of 8% or more.
Then again, it is possible to earn 8% a year in a regular-savings account -- one which requires you to make fixed monthly deposits for a year. However, if you don't want to drip-feed your money in over twelve months, but want to earn high rates of interest on a lump sum, then your best bet is to save using fixed-rate bonds.
The name's Bond: fixed-rate bond
With a fixed-rate bond, you can earn super-high, fixed rates of interest in return for tying up your money for a fixed period. During this time, you can neither add to nor withdraw your savings. However, as the following table shows, this inflexibility enables you to earn table-topping rates of interest:
Account | Yearly rate (% AER) | Fixed period | Minimum deposit (£) |
7.20 | One year | 1,000 | |
FirstSave Fixed Rate Bond | 7.10 | One year | 1,000 |
Icesave Fixed Rate Savings | 7.06 | One, two or three years | 1,000 |
7.05 | One year | 500 |
Source: The Fool's independent, unbiased savings search engine
In short, if you have a spare grand or two and are willing to squirrel this away for a year, then you can earn interest rates in excess of 7% a year. Furthermore, it's worth pointing out that the rates paid by fixed-rate bonds were even higher earlier in the year. In the past week alone, Fool partner Moneyfacts has seen more than thirty rate cuts and product withdrawals among fixed-rate bonds. So, don't hang about and risk missing out on these inflation-beating returns, as these rates won't be around forever...