A real return on savings

Oran A. Hall, Contributor

QUESTION: Given that the inflation rate is often above saving rates for various account types being offered by financial institutions, and attached to these accounts are various fees for holding and transacting with such accounts, is there any real way to save above the inflation rate and avoid account management fees?

- J. Green

FINANCIAL ADVISER: Savings accounts are not the only option for individuals who choose a conservative path to earning interest on their funds.

What is generally common of instruments that are used to earn interest is that they tend to give a return which is less than the rate of inflation; this is what is called a negative real return.

Savings accounts at the various financial institutions pay very low rates. Term deposits, or fixed deposits, tend to pay more, but they are also low and the money is generally less accessible. Before deciding in what type of instruments to put funds, be clear about the reason for placing money and how soon it will be needed.

The fees that the financial institutions charge are an issue of a different nature, but I need to let you know that you will generally incur charges when you engage in financial transactions. You will not always see them.

In some cases, the institutions take a spread as they often sell to you at a higher price than a financial instrument has been bought for, or pay a lower rate than the rate paid by the issuer.

In fairness to yourself, you should seek out better rates than the deposit-taking institutions pay, but there is no guarantee that you will earn a real rate of return as you could still get a rate that is lower than the inflation rate.

The Bank of Jamaica has estimated that the inflation rate for the period April 1, 2012 to March 31, 2013 was between 7.5 per cent and 9.5 per cent. The rate on one-year term deposits for sums of J$1,000,000 to J$4,999,999 is generally less than 50 per cent of the inflation rate.

Even the
money-market funds of the unit trusts did poorly against inflation in
the last 12 months, and the trend is set to continue at least to the end
of the year.

Compare this to Treasury bills. In the
auction held on July 24, 2013 for T-bills with a 182-day maturity, the
average yield was 7.88 per cent. Actually, the yield would likely be
less to you if you used the services of an investment
dealer.

Moreover, as an average rate, you would
reasonably expect some purchasers of Treasury bills to earn more and
others less than the average yield.

The news overall
is that savings accounts and short-term interest-earning instruments are
not doing well in relation to inflation.

The
long-term instruments like the Government of Jamaica 2030 Benchmark
Note, which has a coupon of 11.875 per cent, are the instruments that
are beating inflation in terms of the gross interest that they
pay.

After tax, the return does not look so
attractive, and if you fastforward to when it matures, can you imagine
how badly battered the purchasing power of the principal would be
then?

Oran A. Hall, a member of the Caribbean
Financial Planning Association and principal author of 'The Handbook of
Personal Financial Planning', offers free counsel and advice on personal
financial planning. Email finviser.jm@gmail.com.