Beating the ravages of inflation remains a big challenge for savers

THINGS became more difficult for savers this week when it was announced that a prime inflation beater was to be no more.

At a time when savers are faced with rates on most deposit or cash-ISA accounts significantly below the rate of inflation (effectively losing money in real terms), National Savings & Investments said it was withdrawing its index-linked and fixed-interest savings certificates. Savings certificates offered tax-free returns with the added security of being backed by the government.

There are 866,000 holders of the fixed-interest savings certificates and 587,000 of the index-linked versions, with people previously being able to save between 100 and 15,000 in each issue. However, with AWD Chase de Vere clients, it has been the index-linked versions which have proved by far the most popular in recent months, offering a return of 1 per cent plus the rate of inflation as measured by the Retail Price Index (RPI) over a period of three or five years.

Remembering that returns on these certificates are tax-free, this represents a very competitive return especially for higher rate taxpayers.

The current high level of inflation has also encouraged investments with the RPI Index standing at 5 per cent; this is considerably more than the alternative measure of inflation, the Consumer Price Index (CPI).

While returns on index-linked savings certificates are based on future rather than historic rates of inflation, it doesn't seem as if we will get back to the government's 2 per cent target any time soon.

The move to withdraw index-linked savings certificates is the first time since their launch 35 years ago that they have been closed to new business. This follows NS&I taking in a massive 5.4 billion of new business in the first quarter of the year, this when they are required to broadly balancing the funds coming in with those leaving. It is therefore not really a surprise that they have withdrawn these products to stop the inflows of money.

The good news for existing savings certificate investors is that they will not be affected by this news and at maturity of their certificates can roll over their money.

Savers not already invested in savings certificates, will need to consider other options, particularly if they are keen to beat the ravages of inflation.

For cash savings it makes sense to use your annual cash-ISA allowance, which is 5,100 for the 2010/11 tax year and will rise by the rate of inflation in April 2011. However, most cash-ISA accounts are not paying interest which meets the current rate of inflation, even if using the CPI measurement. This situation is much worse for taxpayers investing in cash outside of an ISA, who face paying income tax of 20 per cent, 40 per cent or even 50 per cent on what are likely to be paltry interest rates anyway.

It is entirely possible we will see an upsurge of interest in NS&I Premium Bonds, particularly amongst higher rate taxpayers who will benefit most from tax-free returns. While Premium Bonds can have their place for those investors who can take the chance of receiving low or even no returns, they are not suitable for those who require a regular income or who are basing their investment strategy on beating inflation and maintaining the real value of their assets.

While investing in gold is often promoted as a hedge against inflation, this is an asset that produces no income or earnings, and is a high-risk strategy, because of price volatility.

Rather, for all but the most cautious or the most ultra-aggressive investors, the best approach to beat inflation is to hold a diversified investment portfolio containing shares, fixed interest and property. The mix of investments should be determined by the circumstances and risk profile of the investor and for some investors other asset classes, such as alternative investments, can also be considered.

A diversified investment portfolio should contain a wide range of investment funds, perhaps including the following: Artemis Income, Schroder UK Alpha Plus, Cazenove European, JPM US, JPM Emerging Markets, Fidelity South East Asia, Fidelity Sterling Bond, M&G Corporate Bond, L&G High Income and M&G Property Portfolio.

However, investors must accept that even a diversified portfolio can fall in value and so it is important that it is reviewed regularly.

• Patrick Connolly is a certified planner at AWD Chase de Vere