How your savings can STILL beat inflation

Just when savers thought things couldn't get any worse, more providers - including Nationwide, Aldermore and NS&I - are slashing rates

14:49 25 November 2012

Just when savers thought things couldn't get any worse, more providers - including Nationwide, Aldermore and NS&I - are slashing rates and now, just for good measure, the cost of living has risen again too.

 

Inflation, as measured by the Consumer Prices Index, rose from 2.2% to 2.7% last month, while the Retail Prices Index, which includes mortgage interest costs and council tax, increased from 2.6% to 3.2%.

 

The latest hike means that a basic rate taxpayer now needs a savings account that pays at least 3.39% to gain benefit in real terms from their savings. A 40% taxpayer needs to earn 4.51%, while a 50% taxpayer needs to earn a hefty 5.41%.

 

Best savings deals not stacking up

 

The bad news is, this is impossible. Even the leading easy access savings account - Tridos Bank's Online Saver Plus - pays a rate of just 2.50% AER (with a 1.50% bonus for 12 months) on a minimum investment of £1. And, as the name suggests, this account is online only.

 

M&S Bank's Everyday Savings account pays an AER of 2.35% (with a 1.00% bonus for 12 months) also in exchange for a £1 deposit while, if you can lay your hands on £1,000 to pay in, Nationwide's Easy Access Loyalty Saver Issue 2 pays 2.40% AER. This account can be opened and operated online or in branch.

 

The good news is there are alternatives to traditional savings accounts which could help you beat rising living costs and actually deliver a return on your cash. So what are they?
 

Regular savings accounts

 

So long as you already bank with first direct (it's worth knowing that, even if you don't, you can currently get £125 cashback for switching to its 1st account through MoneySupermarket), you will then be eligible for its Regular Saver account. This pays a whopping 8.00% AER on regular deposits of between £10 and £300 a month.

 

Make the most of tax-free returns

 

And don't forget about your tax-free ISA allowance. This year, you can save up to £5,640 into a cash ISA and from April 2013, you will be able to top up this balance with whatever the new allowance is then.

 

If you need easy access to your money, then ING Direct's Cash ISA, which can be opened with a minimum investment of just £1, pays 2.80% tax-free, and this rate is guaranteed to remain the same for 12 months. You cannot make transfers into this account from existing ISAs.

 

Alternatively, West Bromwich Building Society's WeBSave ISA 7 pays 2.52% tax-free on a minimum investment of £1,000. This rate includes a bonus of 1.00% which is only payable for the first year, so you may want to move your money at the end of this period.

 

The highest returns on cash ISAs go to those who can afford to tie up their savings for a year or more. For example, Santander's 2 Year Fixed Rate ISA currently pays 3.30% tax-free on a minimum investment of £500.

 

Fix your money and your rate

 

If you have already used your ISA allowance for this year, then your only chance of beating inflation with a normal savings account is by saving into a fixed rate bond.

 

Triodos Bank's five-year Ethical Savings Bond for example, pays 3.75% AER and can be opened with £500.

 

If you can't afford to tie up your money for that long, then unfortunately no shorter-term bonds currently beat inflation. FirstSave's 1 Year Fixed Rate Bond 22 for example, tops the table for one year bonds with an AER of 3.00%, although this requires a minimum deposit of £1,000.

 

Look into structured bonds

 

Investing in stocks and shares with a structured bond is another option.
Structured bonds, otherwise known as capital-protected plans, promise to give back your full capital investment after a given term, plus a return linked to the performance of a stock market index, such as the FTSE All Share or FTSE 100. They therefore enable investors to benefit if stock markets rise, yet still get their money back if they fall.

 

But there are several catches to watch out for. Most of these accounts, for example, have a five or six-year term, and you won't be able to access your funds during this period. Big penalties can apply if you need to get your hands on your money early.

 

In addition, any guarantee or protection is only as good as the financial strength of the institution offering this protection, so you will need to be confident that the company providing your plan is financially stable.
Finally, it is worth bearing in mind that because returns are only linked to a stock market index, rather than investing directly in stocks and shares, you don't have the advantage of dividend income, which can make up a major part of investment returns.

 

Remember too that if markets fall over the investment term, although you will still get your money back, its purchasing power may have been significantly eroded by inflation.

 

If are happy to accept these risks, and are looking for a structure bond offering growth, then Investec's FTSE 100 three-year Deposit Plan 38 will pay a fixed return of 13.50% after three years, providing the FTSE 100 is higher than its starting value at the end of the three-year term. If the FTSE is lower, however, no growth is paid, and you will only receive your original capital back. You can open this plan with a minimum investment of £3,000.

 

Investec has a five-year plan, the Investec Kick Out Deposit Plan 33 which offers a maximum potential return of4.75% for each year it's been in place and can mature early from year two provided the FTSE 100 is higher than its starting value. If these conditions are not met, you will only receive your original capital.

 

For more on structured bonds, read Esther Shaw's article but bear in mind that all rates are only correct from the time of writing.

 

Lend to your peers

 

Social lending firms, or peer-to-peer lenders, offer another alternative for consumers looking to maximise returns. These either lend to other individuals or small businesses - banks are sidestepped so those willing to lend get higher returns and businesses or individuals get lower cost loans.
According to peer-to-peer lender Zopa, after charges and defaults, its lenders earn an average return of 5.4% - that's more than double even the best easy access account in the market.

 

Meanwhile, at RateSetter, average returns for investors range between 3.00% and 6.00% depending on the type of the account. For example whether the loan is paid back to you all at once, or monthly over a given time period.
Funding Circle, which lends to small companies rather than individuals, offers returns averaging 6.10% once all fees and bad debts have been factored in.
Bear in mind, however, that peer-to-peer lending sites are not covered by the Financial Services Compensation Scheme (FSCS) which protect the first £85,000 of your savings held per banking institution in the event it goes bust. However, the money invested is usually divided into lots of small parts which is then spread over different borrowers, therefore reducing your exposure to one individual.