It used to be that if you wanted to get a rate on your savings that would beat inflation you got a cash Isa, the idea being that with no more tax to pay on your interest you’d be bound to make a real return. But look at the rates on offer and you’ll see that is no longer the case.
The best rate is a mere 2.85% (the Santander Flexible Isa), which is rather less than the current rate of inflation as measured by the Consumer Price Index of 3.1%. Still, while it is a terrible rate, you do end up with more in your pocket than if you got the same rate outside an Isa (and you probably won’t get a better one). After paying tax, a 20% rate payer would end up with an effective interest rate of only 2.3%, and a 40% taxpayer a mere 1.71%. That adds up to the kind of negative real return that isn’t much good for anyone. At the moment, your cash loses purchasing power every single day, regardless of your tax band.
So what do you do? The authorities, clearly, want us to take more risk with our money. That’s why they are threatening us with endless rounds of quantitative easing and permanently low yields. They want us to either get out there and spend, spend, spend our savings to compensate for their intention to stop doing so, or to invest our savings properly to help them in their efforts to prop up the asset markets.
Most of us should not do the former, given the state of the UK economy and of our employment prospects (however tempting the arrival of Christmas displays in Marks and Spencer may be). But we should, I think, be doing at least a little of the latter.
Regular readers will have noticed I am increasingly more nervous about inflation (or, to be more precise, stagflation) than deflation. That’s not because I have come over all positive on Western markets, but because I am increasingly impressed by the lengths to which central bankers intend to go in their battle to defeat their stated foe (deflation). And because I suspect this is one battle they will win, albeit not quite in the way they hope.
The wonderful Paul Volcker, former chairman of the Federal Reserve, recently accused central bankers of being “a little too infatuated with their own skills” during the bubble. Perhaps they still are, and with their eyes so firmly fixed on avoiding the Japanese experience that they are fighting the wrong battle. They might be discounting too much the fact that China has shifted from exporting disinflation to exporting inflation, and paying too little attention to the way the current levels of commodity price inflation will feed back into consumer price inflation.
They might also be relying too heavily on the fact that we have high unemployment and idle manufacturing plants aplenty to prevent their experimental money-printing policy, QE, producing inflation.
Either way, I think the risks that our current stagflation (inflation combined with a rubbish economy) will stay with us (and get worse) are high enough that investors need to focus on yield. Luckily, the UK market still offers just that. The current quoted yield on the FTSE 100 is about 3.5%. That’s nice. But it is much better than it looks. If you get your income as interest you pay 20% on it as a 20% taxpayer, 40% on it if you are a 40% tax payer and 50% if you are a 50% payer. Not so with dividends. If you are a 20% tax payer, you pay 10%. If you are a 40% payer, you pay 32.5%. If you are a 50% payer, you pay 42.5%.
There’s more. The quoted yield on the FTSE 100, and indeed on individual shares, is net of tax credit: the number you get told already takes account of tax paid at 10%. So if you are a 20% taxpayer, there is no more to pay. And if you are a 40% taxpayer, there is only another 22.5% to pay. Add that in and it does feel a little foolish to have your money sitting around losing purchasing power in cash.
I am still extremely cautious on stock markets, but I have been suggesting that you buy high-yielding blue chips and defensively-positioned investment trusts for some time now.
I think doing so is getting more crucial: if you want a real return on your money, there isn’t much option. Consider the Edinburgh Investment Trust run by Neil Woodford. It is on a forecast yield of 4.8%, so if you buy it today with CPI at 3.1% and even with RPI at 4.6%, you will, assuming you are a 20% tax payer, actually have increased your purchasing power by the end of the year (assuming, and it’s a big assumption, that you make no capital losses).
That shouldn’t be an unusually brilliant thing. But these days it is.
• This article was first published in the Financial Times