Get a better return on your savings

Neil Faulkner rounds up eight top savings accounts, bonds and ISAs that beat the REAL rate of inflation - because, for most of us, prices are going up!

When it comes to savings rates, your number one priority should be to choose a rate that will beat inflation. This is because inflation - rising prices - indicates the rate at which your money needs to grow, just to stay still.

Confused? It's all about the value of money. If you want your money to be worth the same amount in 12 months' time as it would be worth if you spent it today, then it needs to earn a rate of interest that is equivalent to the annual rate of inflation.

And if you want your money to be worth more than it would be if you blew it all in the shops today - which is the point of saving it up, after all! - then you need to make sure the rate on your savings account will not just match inflation, it will beat it.

But before you attempt to beat inflation, you need to figure out what rate it currently is!

The current rate of inflation

The broadest measure of inflation is the Retail Prices Index. RPI for the twelve months up to April 2009 is minus 1.2%, meaning prices are actually falling. This is called deflation.

However, if we strip out mortgage interest payments - which have fallen dramatically in the last year - it's +1.7%, So this is the average rate of inflation for non-mortgage borrowers.

What's more, your own inflation rate may be wildly different. It all depends on what you spend your money on, compared to other people. So it's worth getting a better estimate using the Office for National Statistics' personal inflation calculator. Last time I checked, mine was a little under inflation but a colleague's was four percentage points above!

Here's what we need to earn

Here's what you have to earn to keep up with RPI:

As you can see, you currently don't need to earn any interest at all to beat RPI. If your personal rate of inflation is also negative, you will effectively be getting richer even if you have your savings in an account paying no interest.

But if you haven't got a mortgage, then the RPI is higher, as you can see.

So it follows that, if you who don't have a mortgage, you need to earn more interest on your savings account to match inflation. The table shows higher-rate taxpayers need to earn 2.84% in accounts that bear interest. But remember, in a Cash ISA or another tax-efficient savings plan, even a higher-rate payer only needs to earn just 1.7% to match inflation.

I've had a quick look at the sorts of rates you can get from a variety of savings products if you shop around. Here are the best rates I found for a variety of products:

Tax-free interest rates are in italics. As usual, I've excluded accounts with the worst catches, e.g. withdrawal penalties in easy-access accounts, and the requirement to open a linked product.

Let readers know if you've found something better than any of those by writing a comment below. You can compare savings accounts and ISAs through lovemoney.com.

With the worst account paying a taxable 2.85%, all of the above accounts will beat the latest RPI measurements whether you pay mortgage interest or not. At the moment...

What if the rate of inflation increases?

If inflation spirals upwards, we may find that savings rates go up more slowly. Banks will drag their feet when raising rates, like they always do. Plus psychologically, many people might be happy to earn 10% even if inflation is at 13%, giving the banks less reason to keep pace.

Rapidly increasing inflation, and even high inflation, is a distinct possibility when the economy recovers from recession. That's why I've not included fixes of more than one year in the table, as I consider these to be simply too risky. The returns on those products aren't currently a great deal higher than one-year fixes or variable rates either.

What other products are there?

Looking to the future then, you may need to eventually take out products that are a little different. When inflation rises again, so will mortgage interest rates, pushing up the RPI figure. This will make National Savings and Investments Index-linked Certificates again attractive. It pays you interest at the RPI rate plus 1%, tax free. At the moment you can buy them for three to five years.

Of course, that deal could be amended at any time, especially with spiralling inflation, but I still believe it's a little early to be putting your savings into these certificates considering ordinary savings accounts are doing so well, as I showed in my table. I'll be recommending this product when the time is right.

A more drastic solution during high inflation times is to become a lender yourself, through Zopa. That's an investment product as opposed to a savings one, but I think it remains an interesting alternative through both good times and bad. Find out what we think of Zopa.

> Compare savings accounts through lovemoney.com