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