Six essential lessons for savers
The financial crisis has helped to illustrate the pitfalls that can strike even the most careful investors.
It has shown that the largest, most respectable institutions are not immune from disaster and the safest of investments can fall in value. But it has also taught us some important lessons that need to be borne in mind when choosing savings and investments.
1. Don't keep all your eggs in one basket
This is the oldest lesson, but one that is frequently forgotten. In 2008, it emerged that some savers had placed their life savings with just one Icelandic bank. The deposit compensation limit was then £31,700.
It has since been increased to £50,000 per licensed deposit-taker. So if you have more than this remember to spread your money around by choosing different providers. But you will need to look behind the brand.
Abbey, for example, is responsible not only for its savings but also deposits in Bradford & Bingley and Asda. However, Alliance & Leicester, which is also part of Santander, has its own license.
2. Monitor interest rates on savings
Savings rates have been slashed in line with the Bank of England base rate and some easy access accounts are paying only 0.1% before tax, so make sure your cash is earning the best rates.
But bear in mind that tempting rates are offered on many savings accounts that aren't always maintained, especially where a temporary bonus has been added. Here, you may be left languishing in a poor-paying account while the institution reserves its best rates for new customers.
3. Don't rely on cash savings only
Inflation reached a high of 5% in September 2008, which exceeded the rate many savers were earning on their deposits. But over 2009, the main measure of inflation has fallen dramatically and the Retail Prices index, which includes housing costs, fell into negative territory. Some economist say this is a temporary blip, other expect the UK to become entrenched in a period of deflation.
As long as inflation remains low, interest rates are expected to stay the same. However, should inflation rise, then while rates will probably rise, there is a danger that the real value of savings will be eroded by inflation.
Over long periods, assets such as shares have historically maintained their value against inflation better than cash. So do not ignore your stocks and shares ISA allowance as it could help protect the purchasing power of your capital.
4. Diversify your investments
Property values plummeted last year. There was a 16% decrease in house prices in 2008 - the largest annual fall since 1991 according to Nationwide. Until recently, some had regarded property as the only investment they would ever need to make.
So it is advisable to diversify investments between different asset types if you can. Although most asset classes have been affected by last year's turmoil, spreading your investments between shares, bonds, cash and property will help you achieve more balanced returns over the long term.
5. Understand your investments
The reason many of the world's banks suffered problems is because they held toxic investments linked to the US sub-prime mortgage market that they did not fully understand. Bernie Madoff, the jailed US investment adviser, was never able to fully explain how he maintained returns, but investors still gave him their money.
Investors who bought two of Legal & General's past capital-protected bonds are unlikely to have realised that their investments were not with the insurer and stand to lose money due to the collapse of Lehman Brothers. So if you don't understand any investments you are offered then don't invest.
6. Remember the Financial Services Compensation Scheme (FSCS) and the Financial Ombudsman Service (FOS)
The FSCS stepped into the breach to help investors in the Icelandic banks and other companies that have gone bust. Few people were previously aware the scheme existed. Besides covering bank deposits, it also covers investments, providing compensation of 100% on the first £30,000 lost and 90% of the next £20,000 up to a maximum of £48,000.
If you have received inappropriate advice you may be able to get compensation via the FOS, but only if the firm is authorised by the FSA. Contact the FSA's consumer helpline on 0845 606 1234 to check out if a firm is covered.
This article was originally published in Money Observer - Moneywise's sister publication - in November 2009
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
If you’ve have a complaint about a financial service product you have bought but the company you bought it from refuses to resolve your problem after eight weeks, the Ombudsman can help. The Ombudsman will investigate and resolve the matter. The Ombudsman is independent and its service is free to consumers. The Ombudsman may find in the company’s favour but consumers don’t have accept its decision and are always free to go to court instead. But if they do accept an Ombudsman’s decision, it is binding both on them and on the business.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.