Extreme stock market volatility and the crisis at Northern Rock have prompted some crass comment about how to look after savings in uncertain times like these. Probably the worst is the glib recommendation, so often trotted out during a panic, that you might as well keep your money under the mattress. But the only people to benefit from financial advice like that are burglars.
Quite contrary to what pessimists might have you believe, anyone can still enjoy risk-free, tax-free returns comfortably ahead of inflation. Meanwhile, the more adventurous may seek to profit from setbacks suffered by others.
Long before the Chancellor, Alistair Darling, hurriedly announced that taxpayers would provide an unlimited underwriting facility for Northern Rock, the government had guaranteed deposits with another retail bank: National Savings & Investments. Perhaps because NS&I pays no commission to financial advisers, the advantages of its bonds and deposits for the risk-averse are often overlooked. But its solidity is a major virtue at times of anxiety and some of its offers are unique. Its tax-free products include an individual savings account (Isa) paying 6.3 per cent, and index-linked certificates which guarantee to pay 1.35 per cent more than inflation over fixed terms of three or five years. Better still, that’s inflation as measured by the retail price index, which is currently rising at 4.1 per cent a year — rather than the Bank of England’s preferred measure, the consumer price index, which would have us believe inflation is only 1.8 per cent. So at present, these certificates are paying 5.45 per cent tax-free and would yield more if inflation increased, less if it fell. Either way, they currently offer risk-free yields which basic-rate taxpayers would need gross returns of more than 6.8 per cent to match. Higher-rate taxpayers would need more than 9 per cent before tax to equal the return on these certificates.
For readers who find their eyes glazing over at all these numbers, what about a flutter where there is no risk of losing your original stake? Most people know that Premium Bonds pay out a £1 million prize each month but there is less awareness that more than a million other tax-free prizes are also distributed over the same period. If you express the total value of all prizes paid out over a year as a percentage of all the money invested in Premium Bonds, you arrive at an ‘equivalent yield’ of 4 per cent tax-free. Of course, there is no guarantee that any Premium Bondholder will receive any prizes at all. But the nearer your holding is to the maximum of £30,000 per person, the more likely you are to receive prizes equal to the ‘equivalent yield’. Even if you only put in the minimum £100, you still have the certainty that you can get your cash back whenever you want, coupled with the dream value of the chance to become a millionaire overnight.
For those who dismiss such fanciful thoughts, there are shares at bargain basement — or at least reduced — prices to consider. The FTSE-100 index fell by about 12 per cent from its peak of 6732 this year to a low-point of 5858 in August, when the market got cold feet about mortgage debt in America. That sneeze on the other side of the Atlantic turned into influenza that nearly killed Northern Rock. But in the zero-sum game of stock markets, one man’s loss may be another man’s gain — and a financial disaster for some is an opportunity for others. Since the summer, shares have made up much of the ground they lost — making the gloom-mongers look pretty foolish and pushing up the yields which shares and share-based funds offer investors. For example, at the time of writing, dividends paid out by the shares that make up the FTSE-100 are just above 3 per cent of their market price.
That may sound nugatory but remember it is net of basic-rate tax, like all dividends on British equities, and history suggests there may be further gains to come in the form of capital growth. Those inclined to scoff at that statement may recall there were plenty of worldly-wise men forecasting a stock-market meltdown in August. And, because perennial pessimism is an easy way to simulate wisdom, there are always plenty of experts calling the top of the market — all the way up.
Here and now, one fundamental measure of value, the price/earnings ratio, shows that it would take a little more than 12 years for the earnings on FTSE shares to match their market prices. That’s not screamingly cheap but compares with a p/e ratio of 15 at the bottom of the bear market in March 2003, when the index was half its current level.
How can that be so? Because corporate earnings have risen even faster than equity values since then. Still more encouragingly, share prices expressed as a multiple of earnings per share are less than half as expensive today as they were at the top of the bull market that ended in December 1999, when the FTSE hit an all-time high of 6930 and the p/e ratio exceeded 30.
So, while risk-free deposits are all very well for short-term savings and Premium Bonds are fun for a flutter, shares and share-based funds are likely to continue to provide higher returns for investors willing to take a longer view.
Ian Cowie is personal finance editor of the Daily Telegraph.