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Mowatt Financial Planning: May 2011

Tuesday, 17 May 2011

Inflation

The latest inflation figures released today for March show CPI going up to 4.5% from 4.1% and RPI going down from 5.4% to 5.3%. See more detail on the ONS site.

The main difference between the two measures are the costs included (RPI includes mortgage interest and other housing costs) and the method of calculation (RPI excludes the highest earners and some pensioners dependent mainly on state benefits).

According to the Bank of England Quarterly Inflation Report, the outlook for inflation remains high for the remainder of the year and above the target of 2% in 2012. The view is that inflation is then likley to fall through 2012 into 2013.

The chart to the right shows the Bank of England inflation projection.

Clearly the inflation rate is more uncertain the further away the forecast.

Monday, 16 May 2011

Index-linked savings certificates

Last week National Savings & Investments relaunched a 5 year index-linked savings certificate. There should be a place for them in most portfolios.

They are not quite as good as the previous issue: lower interest rate above inflation (0.5% on average) and only 5 year term available. However, they can be cashed in before the end of the 5 years.

The interest is as follows:

Year 1 RPI plus 0.25%
Year 2 RPI plus 0.35%
Year 3 RPI plus 0.4%
Year 4 RPI plus 0.65%
Year 5 RPI plus 0.86%

The proceeds are tax free.

Although you might be able to get a better deal on a fixed term bond, with these you know you are protected against inflation.

The big unknown is what will happen with inflation. Currently the RPI is at 5.3% and the expectation is it will stay high for some time before it falls.

The comparison below shows how the return might vary under different inflation scenarios and also shows the return against a 5 year fixed term bond and a variable rate savings account.

Returns are for an initial investment of £5,000 and represent the value at the end of the 5 year period.










The returns under the index-linked savings certificates vary from £5,909 to £6,291 under the different inflation scenarios. Importantly there will be no tax to pay.

The returns under the 5 year fixed term bond are £6,095 (net of basic rate tax) and £6,397 for a non-tax payer.

The forecast returns under a variable rate savings account vary between £5,944 and £6,200 for a non-tax payer.

I believe it's a good idea to hedge your bets and with the uncertainty of exactly where inflation will go, index-linked savings certificates are a good option for some savings where the goal is 5 to 6 years away.

Assumptions:
Scenario 1: Inflation of 5%, 3.5%, 3%, 3%, and 3% over the next 5 years.
Scenario 2: Inflation of 5%, 3.5%, 2%, 2%, and 2% over the next 5 years.
Scenario 3: Inflation of 5%, 4%, 4%, 4%, and 4% over the next 5 years.
Fixed rate 5.05% (currently available from Birmingham Midshires)
Variable rate: 3%, 4%, 5%, 5%, 5%
 
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