How to protect your savings from the ravages of inflation

That old chestnut — if your money is neither invested nor earning interest then it is losing value — is sometimes a little hard to digest. It would be a lot easier if the figure you saw on your bank balance reflected your money’s purchasing power, because then we would all have more clarity.

But for now we are stuck with estimates and projected figures. According to Lloyds Bank, for example, if you have €1,000 in your current account and assume a rate of inflation of 2.5 per cent over the next five years, at the end of that you will only have €884. In other words, while your balance might still show €1,000, you’ll only be able to buy €884 worth of goods with it. If inflation were to run at 5 per cent, you’d be left with just €784.

It’s no surprise that advisers are blue in the face telling people to seek a return on their money — if not to make a profit, then at least to retain its current value. So for beginner investors looking to set up a portfolio, what types of investments might they consider and what are the risks, costs and timeframes involved?

GETTING STARTED

Potential investments may include anything from shares and funds to bonds, or a combination of all of these. While you can certainly opt to buy shares, ie a stake in a particular company, the task of choosing which companies to buy into — and the high risk inherent to any concentration of capital — is why most newbie investors put their money into more collectivestyle vehicles such as funds.

There are various types of fund, but a typical mutual fund pools multiple investors’ money and directs it into an array of companies; depending on the type of fund these may straddle different sectors and/or regions. Some multiasset- style funds will also put part of the investment into bonds, property or cash. There is usually a human fund manager behind them.

Exchange-traded funds (ETFs) have become increasingly popular due to their low cost. Like shares, an ETF is traded on a stock exchange but that’s where the similarity ends. That’s because an ETF — a bit like a regular fund — is made up of a wide mix of preselected stocks/shares, bonds and commodities. Unlike funds, however, most are passively managed.

At the lower end of the risk scale are bonds, both government and corporate. When you invest in a bond, you are essentially lending money to a government or company, which agrees to pay you back at a fixed return.

There are other types of investment that you can ask your adviser about; among them are money market funds, commodities, hobby investments such as art or wine, and peer-to-peer lending. All have different costs and risk profiles.

RISK/RETURN

All investment comes with some degree of risk as, in contrast to holding cash on deposit, there is no deposit guarantee scheme waiting in the wings should things go awry. However, there is a spectrum. If you have an adviser they will help you find a risk level you are happy with.

As a general rule, bonds are at the lower end of the scale, followed by mutual funds, ETFs, stocks and alternatives such as commodities. Higher-risk options promise higher returns, though there are no guarantees.

TIMELINE

As a general rule, the longer you can leave your money invested, the better. Buying and selling within short periods is classed as speculation and is high risk. Therefore most advisers recommend that if you cannot leave your money for at least five years you would be better off seeking another option, such as a high-interest savings account.

“If capital is needed in the short term [less than five years], the asset class for the investment will be very similar to that of the emergency fund,” says Paddy McGettigan, managing director at McGettigan Financial Planning.

FEES

The question of fees is a hugely important — and potentially complex — one. While some investments, notably ETFs, are fairly reliably low cost, with the rest you need to be really careful. That’s because there is a whole range of fees you can be charged, whether as one-off payments or — more worryingly — as ongoing yearly deductions, which can severely eat into any gains over time.

Before you proceed with any investment, get your adviser or broker to spell out in minute detail — and put down in black and white — precisely what fees you will pay (to them as well as to any other fund manager involved). Push them on this until you are absolutely clear as to how it will affect your investment.

TAX

In most cases you will have to pay exit tax of 41 per cent on any gains you make from your investments. This is levied when you sell, but also every eight years even if you have not sold. Most collective investments, such as funds and ETFs, come under this system. If, however, you invest in individual stocks, you will pay the lower, capital gains tax rate of 33 per cent (with the first €1,270 of your gains being tax free).

DUE DILIGENCE

According to Grainne Griffin, director of communications at Competition and Consumer Protection Commission, before you start down the investment road it is important to take a step back and look at your finances. “Don’t rush into investing,” she says. “Be honest about how much you can afford to lose, make sure you understand the level of risk, and consider getting professional financial advice — especially before you invest for the first time.”

She recommends checking the Central Bank’s register of financial advisers to be sure you get someone who is qualified and regulated. “Remember you may be able to access free financial advice if you’re a member of a trade union or through certain employee assistance programmes,” she adds.

Watch out for investment scams. “Urgency is a red flag; beware of anyone telling you to invest quickly,” Griffin says. “People have lost their life savings through investment fraud, so take your time and build your knowledge before you make any decisions about your hard-earned money.”

Also, McGettigan says, before you siphon even a cent of your cash into an investment portfolio, make sure you have a solid emergency fund set aside. If you are wondering how much is a good amount, he suggests a figure of about six times your gross monthly salary. “In the event of job loss or an unseen stop in income, this will maintain your lifestyle for the near future,” he says. This money will of course need to be kept as cash so that it is easily retrievable in a hurry. “The savings are unlikely to keep pace with current inflation but will serve the specific need of having an emergency fund to access.”

And finally, when it comes to investing, patience is very much a virtue. “This isn’t a straight-line investment; volatility is the price of growth and patience will be required,” McGettigan says.