Stop inflation eating your savings

published 31 October 2005

Not many of us understand the real effect of inflation on our investments, says Mark King in Money Observer. But the impact can be huge. In today's low-interest-rate environment, you can easily find your savings in an account that pays such a low rate that after tax and inflation you end up with less spending power than you started with (if you get 3.5% on your account, and pay 40% tax when inflation is 2.5%, you are actually making a negative real return of 0.4%). But perhaps those most at risk from their failure to understand inflation are people who have borrowed heavily in the past few years. In a high inflationary environment, salaries rise at the same time as the real value of your debt falls. This makes it easier to pay off. But when inflation is low, the real value of debt is not eroded in the same way. That makes borrowing even more dangerous than usual - even if interest rates look very low.

For savers, there is a way to make more than inflation is stealing from you, says Lorna Bourke in The Sunday Telegraph: buy National Savings products. These are widely regarded as dull, but, being tax free, they do have their uses. The new index-linked 33rd Issue offers a return of 1.05% over the rate of inflation, for example. If you reckon inflation will continue to run at around 2.5%, this suggests a return of 3.55% a year - the equivalent of 5.92% to a 40% taxpayer, or 4.44% to a basic-rate payer. You can invest up to £15,000 in Savings Certificates, although the returns are paid only at the end of the five-year term, so you will not get immediate income.