What is the best home for your savings ?
Traditionally deposit and savings accounts have been the save haven of investors looking to preserve the value of their savings. However, with rates of inflation now higher than deposit account rates, savers are now losing the purchasing power of their money each day they leave it in the bank. This leads me to ask the question – what is the best home for your savings?
Local banks, building societies and credit unions have been providers of low cost deposit style accounts which have provided people with a safe place to hold their cash, savings and rainy day money.
Deposit and savings accounts have been regarded as a 100% safe home for your money. You might not make much in interest – but your savings are guaranteed not to fall in value. In the UK if your bank of financial institution fails, then a government guarantee covers 100% of the value of your deposits up to a figure of £85,000. People value this safety net.
This guarantee was backed up during the recent financial crisis when banks and other financial institutions began to fail. When the Northern Rock got into liquidity difficulties and queues of depositors started forming outside its network of branches trying to take their money out, the government immediately stepped in and publicly guaranteed depositors savings. They did the same when the Icelandic Bank “Icesave” entered administration a couple of months later.
This guarantee is invaluable, and allays peoples’ fears that they might lose money. It’s a system that’s replicated throughout the European Union, and gives savers the confidence to trust banks to “mind” their money. In the USA savers get $250,000 federal insurance on their Certificates Of Deposits.
Most people are scared stiff of losing money and won’t entertain any sort of investment which puts the value of their hard earned capital at risk.
For this reason – many financial institutions offer products which prey on peoples “fear of losing money”. They don’t need to offer attractive rates of interest when none of their competitors do.
A good example of this are the fixed rate bonds and fixed rate CDs (Certificates Of Deposit) which banks offer over 1,2,3 and 5 year periods. These savings vehicle are available through banks in all “1st World” nations.
In the UK the best 1 year fixed rate deal is 2% (1.6% after tax). In the USA the best 1 year CD rate I can find is a paltry 1.05%. Its the same with 5 year fixes in the UK the best rate on a 5 year fix is 3% and in the USA 2.02%.
Why would anyone want to lock their savings into a long term deal that’s below the rate of inflation?
Obviously the banks love these form of investment schemes. They get to use other peoples money at very low cost – which they can then lend out to the same people via auto and personal loans at much higher rates of interest. The difference – “the margin” – is what enables most banks to target a minimum return on capital for their investors of 10%pa.
Is it better to put your money in the bank – or – buy shares in the bank ?
In the current economic climate of artificially low Interest rates, it’s virtually impossible to find deposit type savings accounts which match or beat inflation.
This means that every day that you keep money in a deposit account, a fixed rate CD or Bond – even though the value of your money is rising – the purchasing power of your money is falling in real terms.
This is terrible – the banks are screwing us all down.
It’s forcing savers to take on higher and higher levels of investment risk in order to find a positive return on their savings. Risks that many people can’t afford to take.
In the grand scheme of things – after discounting saving and deposit style accounts the next step on the risk/reward ladder is the gilt and bond market. Usually gilts and corporate bonds are seen as very steady investments. Never to set the world alight with stellar returns, but providing a safe return with low market volatility.
(When i discuss bonds here – I’m not talking about the European version of CDs, but the IOU style bonds issued by governments – called gilts, or issued by corporations – called bonds).
However – my own personal view is that bonds and gilts have entered into a bubble scenario and aren’t the safe haven that they once were.
Interest rates have been kept artificially low for a long period of time now, and central banks have indicated that they are likely to remain at low rates for the foreseeable future, and bonds and gilts have been the default choice for people looking to get a good low risk return on their money.
This flood of money looking for a “safe haven” has resulted in bond and gilt prices being pushed high above their true value – giving investors a negative yield on investments.
Why would anyone invest in an investment with a negative yield?
As soon as interest rates start rising back towards their long term average of 4% – which they inevitably will – there will be a bloodbath in the bond market as investors bail out.
Remember that there is a direct correlation between the value of bonds and prevailing interest rates.
If interest rates rise – the value of a bond falls.
Its an opposite scenario when interest rates fall – the return on bonds increases and so does their value.
So – savers are faced with a hard choice.
Leave the money in the bank – and let its value be slowly eroded by the ravages of inflation.
Buy bonds or gilts in what is becoming an ever more risky and over inflated market?
Or expose your savings to the stock markets – which despite giving an average return of 10%pa over any historical 10 year period, can suffer from wild plunges in value over short periods of time, causing nervous investors to panic and sell at the worst possible times.
It’s a real savers conundrum – which I’m going to explore in greater detail in upcoming posts.
What do you think? What is the best home for your savings?
Are you getting a positive rate of return on your savings or have you been forced into investment markets in order to get a positive return?