Banking/Savings Section

Understanding The 'Real Rate of Return' It's Simple, But Critical

November 2005

There are two main reasons why the banks can get away with offering the public a generally bad service combined with outrageous fees and charges. Firstly, client inertia (ie can't be bothered to move accounts etc) and secondly the banks know that many of their clients do not even understand the basics of personal finance and money. The banks therefore in many cases have carte blanche to do what they want.

A Little Financial Education Can Go A Long Way

Financial education doesn't have to be hard, and just a firm understanding of the basics is all most people need. But realise the importance of education. Most people these days are interested in either having more pounds in their pockets or in saving money, education can easily offer you both.

Remember that many of the banks work on the principle that if clients don't really understand what they're buying then they also won't realise when they're overcharged or sold products they don't need. Of course the informed buyer will be able to spot these kinds of traps and be in an excellent position to get the best deals on offer. Educated buyers can either save extra money or make it - perhaps even both.

One Of The Foundations Of Financial Education - The 'Real Rate Of Return'

• Inflation is where things generally cost more in the future than they do today
• For example, a Mars bar cost 20p 8 years ago and today it costs 40p, that is inflation at work
• A yearly inflation rate of less than 2% is considered natural
• Note, that a steady inflation rate of 2% means that £100 in your pocket today will only be worth £98 in a year's time
• Therefore higher inflation not only means that things will cost more in the future but also cash money will be worth less, a nasty double negative which in this case does not make a positive
• The real rate of return is therefore an interest rate minus inflation, if you are receiving 2% interest on your savings with 2% inflation then your money is treading water, so although you will have £102 in savings in a year it will have no extra purchasing power
• Right now basic rate tax-payers need to earn at least 2.9% on their savings to combat inflation, and higher rate tax payers need to earn 3.8%+
• If some or part of your savings money is receiving interest at less than this amount then quite simply you're losing money even though you might not realise it!

Summary

As you will have seen from this article having a simple grasp of what inflation is and subsequently the real rate of return can make such a difference as to how you save or invest your money. So if you're earning less that the real-rate on your savings do something about it and take your business to a savings account that pays a decent amount.

We like both ING Direct and the Nationwide which both pay 4.75% per annum.

See Also

• ING Direct pays 4.75%, minimum £1 deposit
• The Nationwide Building Society
• Find's List of Saving Account Links