FOOL'S EYE VIEW
Your Ultimate Guide To Saving!

By Cliff D'Arcy
January 31, 2006

Way back in the Seventies, my parents opened a children's savings account for me, plus one for my sister.

Can you guess what I did with mine? Yup, I cleaned it out as soon as any money went into it, eventually closing it sometime in the Eighties, prior to heading off to university. My sister, however, became a sensible saver, putting a little aside as she went through life. What's more, her good habit was rewarded with windfall shares when her building society converted to a bank in 2000.

Not only did I fail to get the savings bug from an early age, I did my utmost to splash my cash without a care for tomorrow. Indeed, by 1998, I found myself on the sharp end of debts totalling £50,000 -- and digging myself out of this hole was no mean feat!

Anyway, to cut a long story short, I've been a borrower, not a saver, for all but the most recent years of adulthood. Despite working in financial services for nineteen years, it's only since the turn of the century that I've become a serious saver. Here are ten lessons that I've learned about savings accounts on my painful journey from being a bothered borrower to becoming a sensible saver:

Lesson One: Pay off any expensive debts first

The Bank of England's base rate is just 4.5%, which is low by historical standards. Thus, it's nigh on impossible to earn more than, say, 5% a year from a deposit account (and that's before the taxman takes his cut). On the other hand, the average rate charged by a credit card is 15½% a year, while all but three store cards charge between 18% and 31% APR.

Hence, it makes little sense to earn post-tax interest of, say 4% when you're paying double-digit rates of interest on your debts. By all means, build up an appropriate emergency fund to tide you over the tough times, but try to throw any spare cash at your debts first. Otherwise, you'll be losing money, not saving it!

Want to avoid paying interest on your debts? Transfer them to a 0% credit card today!

Lesson Two: You are spoiled for choice

According to the Bank of England, UK residents had total savings of £544 billion by the end of September 2005, which averages to nearly £22,000 per household. In case you're wondering where your twenty-two grand went, this money mountain is very unevenly distributed, with the majority being owned by a few million wealthy individuals. Perhaps your boss or a well-heeled neighbour has your share?

Alas, I'm willing to bet that the vast majority of this wealth is stashed away in decidedly inferior accounts. One reason is that there are so many different accounts to choose from, including children's, easy-access, fixed-rate, mini-cash ISAs, monthly interest, no-notice, notice, offshore, regular savings, TESSA-only ISAs and variable-rate accounts.

In fact, the Moneyfacts database lists over four thousand different savings accounts. Talk about finding a needle in a haystack! Hence, it pays to do your homework before opening an account or moving your money, as I explain in...

Lesson Three: You must shop around for the best rates

The onus is on you to shop around for the best deals, because no-one else is going to do it for you. If you can't be bothered to weigh up a large number of accounts on their own merits, then get an online search engine to do the spadework for you. Our savings wizard is powered by Moneyfacts, the UK's leading provider of independent, unbiased financial data.

Lesson Four: Don't trust your bank -- not even an inch

Do you trust your bank always to put your best interests first? You do? Oh dear, then you're in for some serious disappointments in life! In reality, banks exist to do only one thing: to maximise returns to their shareholders*. No matter how long you've been a loyal customer, your primary purpose is to make money for the bank's shareholders!

Therefore, don't expect your bank to give you its highest rates of interest just because you've been with it for years. In fact, what happens is the exact opposite: banks (and many building societies) give their best rates to new customers, while slashing rates for existing savers on the sly.

It's an age-old technique known as "bait and switch": luring in savers with high rates of interest and then withdrawing accounts to launch similar-sounding replacements. It's also the reason why you should regularly check your interest rate, say, monthly, as even star accounts can turn into dogs!

Lesson Five: Tax slashes your savings rate, so avoid it

If you don't pay tax, you must complete a form R85 (available from your bank or building society) so that the taxman doesn't automatically snaffle a fifth (20%) of your pre-tax interest. If you're a basic-rate taxpayer, you lose a fifth of your interest to the taxman, which turns a rate of 5% gross (before tax) into 4% net (after tax). Higher-rate taxpayers pay twice as much tax (40%), turning 5% gross into 3% net.

With inflation running at over 2% a year, this means that it's really hard to earn a decent "real" return on your savings, after accounting for tax and inflation. One sure-fire way to improve your returns is to avoid paying tax (quite legally) by putting your savings into a tax-free cash mini-ISA. This is nothing more than a tax-free savings account, into which you can pay up to £3,000 per tax year. You can put lump sums into it, pay a set monthly amount, or make deposits in dribs and drabs -- the choice is yours.

A cash mini-ISA is an absolute must for anyone who is sixteen or over and wants to be a saver. The only excuse for not opening one every single tax year is if you want to put the maximum £7,000 into a shares maxi-ISA instead. Of course, you could save and invest tax free by opening a cash mini-ISA and putting up to £4,000 a year into a shares mini-ISA. So, that's two minis or one maxi, but not both, got it?

Lesson Six: There's a lot lurking in the small print

Ah, small print, don't you just love it? As they say, "the devil's in the detail" -- and ignoring the gobbledygook can cost you plenty. For example, before opening a new account, you should check to see whether it includes any of the following:

• Introductory bonuses: increasingly, many accounts -- especially those occupying the Best Buy tables -- boost their interest rate by including a short-term bonus; most are paid for, say, six months, although they can last for up to a year. Make a note of when your bonus ends, so that you can move on if your rate is no longer competitive.
  
• Tiered interest rates: with some accounts, the higher your balance, the higher the rate of interest that your money earns. If you do choose an account with tiered rates, make sure that your balance doesn't dwindle until it drops down into a lower tier. If it does, you may be better off elsewhere.
  
• Withdrawal or exit penalties: notice accounts (see Lesson Nine) lock away your money for a pre-set period -- anything from, say, thirty days to three years. Hence, if you pull out your money early, you'll pay a fine or lose interest for the privilege. Other accounts impose other restrictions on withdrawals: for example, the popular First Direct e-Savings account pays 5% AER on £1+, but each withdrawal causes no interest to be paid for that month, so this is only for patient savers.
  
• Any other strings attached: for instance, a few savings accounts offer market-beating rates of interest, but these come with a catch: you must open a current account with, or transfer an existing account to, the same provider (see Lesson Eight).

Lesson Seven: Beware of accounts with fancy names

Savings accounts with upmarket names, such as Diamond, Gold, Platinum and Premium, must be the cream of the crop, right? Wrong again! As I explained here, more often than not, these accounts are mutton dressed as lamb. Be aware that they are fool's gold and then move on!

Lesson Eight: It pays to save regularly

If you want to earn the highest rates of interest, it pays to become a monthly saver. Not only does this give a boost to your financial discipline, it also gives you access to the very best returns. As I explained in Earn 10% On Your Savings, by committing to make a fixed monthly deposit (usually £25+, payable by standing order or Direct Debit), you can earn 7% to 10% a year in a regular-savings account. Not bad, eh?

Lesson Nine: Notice accounts can usually be ignored

Your goal as a saver is to earn the highest rate of interest that you can, while still having reasonable access to your cash. Although locking away your money for long periods can pay off, in practice, you'd do just as well in a table-topping easy-access account. For example, you could earn a market-beating 5.15% AER by putting £1+ into a no-strings-attached ICICI HiSAVE account. On the other hand, £10,000 in the Halifax 60 Day Gold account would earn 3.1% AER, plus you can't get at your money for two months. Which would you choose?

Lesson Ten: The same goes for your kids

Once you've sharpened your saving skills and found your perfect account, do the same for your kids. Ignore the gimmicks and freebies that come with many accounts; instead, concentrate on finding an account that pays consistently high rates of interest.

On the high street, look for an interest rate of, say, at least 4½% a year. For example, my two little terrors both have Smart accounts with the Nationwide BS (4.76% AER with interest paid half-yearly), though interest rates of up to 10% are available for regular savers. Also, my two year old has a Child Trust Fund, but this money is invested in shares for superior long-term returns. (You can learn more about Child Trust Funds here.)

Here endeth the savings lessons -- I hope that they transform you into a super saver!

More: Check out the great rates in our Savings centre | Visit our Saving for Children centre.

* Cliff owns shares in HBOS and Lloyds TSB.