Don't lose sleep over your savings

There is an old saying among stockbrokers. A gold mine is a hole in the ground with dirt at the bottom and a fool at the top. And millions of people feel that they have been the fools as the stock market gold they were promised has turned to dust. The people who told us investing in shares was a one way bet to see our money grow are now saying that the value of shares could fall further, or may trundle along at around the same level for years. That leaves investors wondering what to do and many are becoming ultra-cautious – they cannot bear the thought that their hard-earned cash may disappear because someone persuaded them to put it into a gold mine that turned out to be a bottomless pit. So where are the safe investments?

‘Safe’ means two things.

· the money you put up will be returned to you in full, and

· when it is returned, or before, you will get some extra money given to you

 

In other words, your money will earn money and you will not take any risk of losing it. A lot of people have been tempted into investing in shares by what salespeople like to call the trade off between risk and reward. If you take a bigger risk they say you get more reward. What ‘reward’ means is clear enough – your money grows. But salespeople usually forget to tell you that ‘risk’ means that the value of the money you invested may be worth a lot less in the future than it is now. Some people have lost most of the money they put into some stock-market based investments. At its worst, you can lose it all. Whether you end up on the risk side or the reward side is largely a matter of luck. It is not a gamble many people are any longer prepared to take with their own money.

A deposit or savings account is the safest way to invest your money. On average, the return you get on money in these accounts is poor – you can earn as little as 0.1%. But if you look around, there are good deals available. Intelligent Finance will give you 4.01% from the first pound on a telephone account. If you are happy to use the internet, you can earn 4.5% on your money with Northern Rock. At that rate, for each £1000 you save you get £45 a year back, or £36 after tax. If you had invested £1000 in the stock-market at the beginning of 2002, by the end of July you would have lost on average £250.

Individual Savings Accounts – ISAs – are simply savings accounts where you do not pay tax on the interest received. You can put up to £3000 into one each tax year. The interest is normally credited to the account once a year and then it starts earning tax-free interest. You are free to take your money out at any time without losing the tax relief. But you can only put in £3000 during the tax year however much you take out. Some cash ISAs do insist on a period of notice before you can take the money out. Currently the best deal is with Cheltenham & Gloucester. It pays 4.5% a year tax-free on a minimum amount of £100. You can put in or draw out money in lumps of £100 and You can operate the ISA though a branch or by post. You are charged £30 if you move your money to another provider. If you want more flexibility in how much you can save, Cheshire Building Society offers 4.3% on the first £1 with no restrictions on the amount you deposit or withdraw. Beware of special ‘introductory’ offers that promise a higher rate – but take it away 6 months later.

You have to be careful with bonds. The word is used for a variety of different products that range from the safe to the dangerous. There are two sorts to look for –Bank or Building Society Fixed Rate Bonds and Guaranteed Income Bonds from insurance companies. They are very simple. You put in your money for a fixed period between 1 and 5 years. During that time you cannot get your money back – or you pay a hefty financial penalty if you do. Over the period of the investment you get a guaranteed rate of interest. For example, if you are prepared to tie your money up for four years Abbey National will give people aged 55 or more 5.45% each year for four years guaranteed. The money is paid to you yearly so it gives you an income, but it is taxable. Other bonds roll up the interest so you cannot get it until the end of the fixed period.

Similar products are also available through an ISA. Leeds & Holbeck building society offers 5.55% fixed for five years. If you put £1000 in and left it for five years, you would have £1310 at the end of that time. You can invest as little as £100. Bradford & Bingley offers 4.65% fixed over three years. So £1000 invested now would be £1146 at the end of three years. The risk you take is that you need your money back within that time and have to pay a penalty.

Guaranteed Income Bonds are similar products run by insurance companies but with two big differences.

· You need to invest more – normally at least £5000 and the more you have the better the deal

· The interest is paid with basic rate tax already deducted which cannot be reclaimed. But a strange loophole means that the extra tax paid by higher rate taxpayers is low.

So Guaranteed Income Bonds are bad for non-taxpayers and good for higher-rate taxpayers.

Before investing make sure that the income and capital are guaranteed – a lot of products that sound similar to Guaranteed Income Bonds do not make that promise. They are linked to the stock market and only give you a guaranteed income by returning some of your capital. At the end of the period you may have little or nothing left of your initial savings.

Probably the safest way to invest is to lend money to the Government. You can do that by buying gilts, also called gilt-edged securities, though their proper name is Government Stock. Gilts produce a guaranteed return paid twice a year. At a fixed date in the future the capital will be repaid. But gilts are not quite so simple as they sound. They are sold in units of £100. For example, 7.75% Treasury Stock 2006 pays you 7.75% on each £100 certificate and guarantees to repay your £100 in September 2006. But you cannot buy the £100 certificate for £100. Each £100 certificate would cost you around £111. You will get £7.75 paid in two instalments in March and September. The interest is taxable but is paid without the tax being deducted. That still seems a good deal. It works out at a rate of interest of almost 7% on your outlay of £111. But remember that in four years time when you cash your investment in, you will only get £100 back for each £111 you have paid out. That brings the effective interest rate down to about 4.7% over the whole period. The arithmetic is complicated but you can find the rates in the Financial Times each day.

You also have to take account of dealing costs – you pay when you buy the gilt – and if you sell it you will pay again. You can buy and sell gilts them through some banks, by post direct from the Bank of England, or through a broker.

The other way to invest in the Government is through National Savings – but interest rates are not very good. The best are the tax-free returns which are particularly attractive to higher rate taxpayers. For example you can get 3.45% taxfree on 63^rd issue of Savings Certificates – that is equivalent of 4.31% if you pay tax at the basic rate or 5.75% if you are a higher rate taxpayer. But your money is tied up for five years.

All the investments mentioned here are safe – your capital will earn money and you will get it back in full. The rewards are not spectacular – but you can lose nothing and you can sleep at night. And that is the real gold standard.

A lot of people already have money invested in stock-market based products such as unit trusts or tracker funds and they can see the value of them falling. If you need the money now either to spend or for your retirement then you have no choice but to take it out and take the loss. If you do not need it now, then in the very long-term the value of shares is almost certain to rise. So it is probably best to leave the money where it is. However, no-one knows how long ‘the very long-term’ is or if in the next few years the value of shares will rise, fall further or stay much the same. In the last century the average price of shares rose in 62 years and fell in 38. In late July this year, the value of shares had fallen back to where it was six years ago. London Business School experts claimed in July that there is only an even chance shares will recover their value in ten years time. Though they still thought shares were the best investment in the long-term.

· Interest rates change daily and you can get current rates for most safe savings and investment products from Moneyfacts

· Gilts - contact the Debt Management Office or call 0800 818 614 

· National Savings and Investments or call 0845 964 5000 

September 2002

e-mail Paul Lewis on paul@paullewis.co.uk