FOOL'S EYE VIEW
Sort Out Your Savings

By Christopher Spink
May 18, 2001

Regular saving is the cornerstone of a successful and rewarding life. If you can tuck away even £50 a month you're well on the way to a happy retirement. It's a good habit to get into. Over a working life of say 45 years that £50 a month would give you a pot of roughly £190,000 if it paid interest of 7% each year.

Of course, if you use some of your savings to buy shares, or groups of shares, such as index-tracking funds, then your returns should rise over the long run. If you manage to get your fund to grow on average by 9% each year, then after 45 years, if you put aside £50 each month, you will end up with about £370,000.

This second route we call investing. It's best to keep your cash savings separate from your long-term investing plans. Everyone should have a stash of money, earmarked for emergencies. Keep back say three to six months' expenses so if you fell ill or lost your job you wouldn't have to disturb your investments.

You may also want to save up money in the short term, say for the deposit on a house, a new car, special holiday, your children's university fees or your daughter's wedding. If so then you'll need to keep this money as cash. Investing in shares should only be done with a long term perspective of five years plus.

How to save

You might think such saving is a simple business. You decide how much you can afford to put aside then you shove it in a deposit account with a bank or building society and watch it grow. But did you know there are nearly 1,000 accounts to choose from? How do you pick the right one?

i) Pay off debts

Before you do anything else, make sure you have paid off any debts which charge a high rate of interest. In other words if you have balances outstanding on credit cards, charge cards, personal loans and hire purchase agreements or are running an overdraft, with annual interest rates of double figures, get rid of them!

This would make more sense than saving up money since not even the best savings accounts nowadays pay 7% per annum in interest. And that's before tax is deducted! Get rid of those expensive debts first, indeed use any existing savings to do so as well.

ii) Work out what you need

Having cleared your debts, then you need to set an objective. Work out how much you need to save, whether for emergencies or a specific event and if it's the latter work out when you will need the money. Decide how much you can put aside. Then you'll have to find the best account for your money.

To do this you'll have to consider three criteria: first, and most importantly, what interest rate the account pays; secondly, how easy it is to get hold of your money when you want it; and thirdly, what special terms the account provider imposes.

iii) Get the best interest rate

As a reference point to find the best interest rate, first find the latest Bank of England base rate. At the moment this is 5.25%. Three years ago the base rate was 7.25%, or over a third higher than it is today. Ten years ago it was 11.5%, or more than double what is at the moment.

Very few banks or building societies will pay you more than the base rate if you lodge your savings with them. Only a fifth of accounts currently available match or better the base rate. Make sure your account does.

Most accounts don't, because they ensnare savers with a generously high interest rate, only to then lower this rate within a year or so. This used to mean that "hot money" moved from account to account, leaving the more apathetic majority in the lower paying accounts. Don't allow youreslf to become a victim though!

iv) Don't be restricted

This brings us onto the second point of access. Five years ago, most banks and building societies offered higher interest rates only to savers prepared to operate their accounts by post or telephone, rather than in branches. They also paid more if you could give 30, 60 or 90 days notice before you needed your money.

The Internet has largely done away with these restrictions. If you manage your account online then you will generally get the most generous rates of 5% or more. At the same time, because banks want to encourage electronic savings, as it is cheaper for them to service, the notice period has largely gone.

Also Internet banks tend to be more reliable. None have yet drastically reduced their savings rates far below the base rate. Again, during a period of expansion they don't want to disappoint new customers as this would give them a poor reputation.

v) Beware of bells and whistles

This lead us to the final point. Some of the rules surrounding savings accounts can be quite complicated. Most commonly Cash ISAs and their predecessors TESSAs fall into this category. If you open one of these tax-free vehicles don't fall into the trap and think you are stuck with that provider.

If you find that your account's interest rates drop, you don't have to grin and bear it! Simply switch to a provider offering a better rate. That new provider will often sort out the tedious arrangements involved in switching your savings.

If you want to have all the facilities of a current account, such as writing cheques, paying bills or anything else, then your interest rates may fall. Nowadays some current accounts like this do pay out fairly generous interest rates, of as much as 5%. However, most pay next to no interest at all.

In any case it's probably best to keep your regular current account separate from your savings pot though, so you're not tempted to dive into it.

Some accounts give you a bonus payment if you stick with them for a certain period. However, consequently you may not get the best underlying interest rate though. Similarly others agree to track the base rate, but also may start at a lower level than other accounts.

Conclusion

Finally a few tips: consider saving money in your spouse's name, especially if he or she pays tax at a lower rate than you do; also unless you want an income from your savings ignore accounts that pay monthly rather than annual interest.

Most importantly, keep an eye on your chosen account's interest rate. If it drops considerably more than the base rate, then consider changing accounts. For more information look at comparison table in newspapers or on websites and look at our online banking centre for good deals.

More: Fool's Online Banking Centre
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