Savings: Safe as the bank of England?

Sadly, leaving your cash on deposit is not the risk-free option many people believe it to be. Picture: Getty

It USED to be that anyone coming into a sizeable amount of money could leave it with their bank and forget about it, confident that it would be safe.

Not any more. Fears over the solvency of UK banks and building societies may have subsided, rightly or wrongly, yet leaving cash on deposit is not the risk-free option of  popular perception.

Since interest rates plunged to 0.5 per cent more than four years ago millions of regular savers have watched as the value of their money has been eroded by inflation.

That also affects anyone with a lump sum to manage. The dilemma facing those who have come into large amounts of money – an inheritance, property sale proceeds or an  investment windfall, for example – has become particularly acute, with interest rates unlikely to rise any time soon.

But working out what to do with cash you may previously have chosen to leave on  deposit isn’t straightforward.

Cash savings accounts may be safe, if you believe that the government will bail out any institution that hits the rocks, yet few products keep pace with inflation. The result, as so many people have discovered to their cost since base rates plunged to 0.5 per cent in March 2009, is that their money slowly loses it value.

However, the alternative isn’t always palatable, especially for those in retirement reluctant to leave their money at the mercy of stock market volatility.

“The problem for retirees is that they’re generally looking for three things,” said Brian Steeples, managing director at the Turris Partnership in Glasgow.

“They want an increase in income to supplement other pension income; inflation proofing, so that the purchasing power of their capital can keep pace with inflation; and security, in terms of a financial institution potentially going bust.”

So how can you achieve all of this without enduring sleepless nights?

The first step is to look at what can be done immediately. Clear or reduce any credit or store cards you have, for example. Find out if you can overpay your mortgage if you have an outstanding balance. Ask yourself if there are things you can do to reduce the inheritance tax (IHT) bill left to your dependents when you die? Gifts to children and/or grandchildren can mitigate IHT liabilities, while you could also check your will is  up-to-date to ensure your assets are distributed as you would like when you die.

In the longer term, however, there’s the matter of investing your money in a way that provides income, security and inflation-protection.

Duncan Glassey is the founder of Edinburgh adviser Wealthflow, which specialises in handling windfalls. He believes the key is to develop an investment strategy that works in all markets while protecting your money.

Crucial to this is achieving diversification – spreading your money among different assets, from cash and property to equities and bonds. The balance depends on your circumstances and appetite for risk.

“Maintaining the intended balance is important because your allocation of assets is one of the bedrocks of the strategy that will help you reach your goals,” said Glassey.

“So we rebalance our investment portfolios regularly by trimming the things that have performed well and adding to the things that have lagged.”

The cash element should start with tax-free individual savings accounts (Isas), while government-backed savings provider NS&I also offers tax-efficient accounts.

“Its most popular product is Premium Bonds, though the returns on them aren’t great and you can only put £30,000 in there anyway,” said Glassey. “NS&I does have other products, including normal savings accounts and cash Isas, and at various times the rates are reasonable.”

Remember that the Financial Services Compensation Scheme only covers up to £85,000 of cash on deposit with each authorised institution in the event of your bank or building society going to the wall.

Diversification is part of getting the equities balance right too, with the idea being to spread your money between different funds and sectors. UK equity income funds are particularly popular among older investors,  according to Steeples.

“These funds produce a dividend income and the better funds produce an increasing income year-on-year for many years,” he said.

“With dividend income currently around 4 per cent a year and increasing year-on-year, this is a very attractive income proposition compared with bank interest rates and other types of income-producing investments.”

Sales of the funds reached their highest level in April for six years, the Investment Management Association revealed this week, reflecting improved investor confidence and growing demand for income.

When markets fall some of that money is likely to flow out of equity income funds. But in many cases that would be a result of investors losing sight of their objectives, said Steeples.

“If your objective is an increasing income stream over a number of years, the notional capital value of your investment is of less immediate importance,” he explained.

Equity income is also an effective way of staying ahead of inflation. It’s not the only-option though. Another is index-linked gilt investment funds, Steeples claimed.

“This is a much under-researched area but from our research we believe a portfolio of index-linked gilt funds is an appropriate core holding for any inflation-proofing element of an investment portfolio.”

That research found that index-linked gilt funds have produced returns at least double the rate of inflation in every four year period since January 2000. In more than half of those four-year investment periods index-linked gilt funds also outperformed the FTSE 100 Index.

Then there’s the need to protect your gains, from keeping an eye on charges and performance to making sure you’re not exposed to more risk than you’re comfortable with.

“When money is tight, people tend to watch their expenses more closely than when they are feeling flush. In the same way, some investors can neglect to monitor their fees and transaction costs when markets are rising,” said Glassey.

“Letting expenses slip is like trying to fill a bath with the plug out.”