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Why a Fixed Income is important for your savings?

13/6/2020

So, you’ve managed to put some money aside and you want to make sure that you get a decent return on it. It can be pretty daunting to put your money into the stock market, where returns aren’t guaranteed. For a more secure way to grow your money, take a look at these fixed income options that can give your savings a safer space to flourish.

We all dream of a more secure financial future, and for many, saving will be the first step on this journey. Once you’ve got a decent pot of cash saved up, it’s important to focus on the old adage that ‘money makes money’ and begin focusing on how you can get a return on your savings.

The importance of growing your savings❗

There are two major reasons why you want to make sure that your savings earn interest and grow:

Inflation — the inflation metric reveals how much prices have increased over the past year. If you hold £1,000 in year one and inflation means that the cost of goods has gone up by a few percentage points, then the £1,000 will be able to buy less in the second year than it would have in the first year. This means that over time, anything you hold in cash (or that does not earn interest) will be losing money in real terms.

Compound interest — often referred to as the ‘Eighth Wonder of the World’, compound interest is a key term in the financial world. It basically means with a constant interest rate going into the future, you’ll earn more and more money over time. Why? Consider that first £1,000 you had in the first year. If you secure an annual interest rate of 3% for the next few years, you’ll have £1,030 at the end of year one. When it comes to the second year, you’ll be making 3% on the £1,030, which means that in the second year you end with £1,060.90. Extrapolated into the future, the amount you earn and keep will get bigger and bigger over time.

By beating inflation and earning compound interest, you’ll ensure that your cash holds its value and grows bigger in the future, setting you onto the path of future financial peace of mind.

How do I make my money grow? 🤔

Once you’ve decided to put your money to work you will have a few options available to you. We’ll highlight the most common ones below:

Bank savings account 🏦

Most banks will allow you to open a savings account with them. Typically, these offer lower variable interest rates. Let’s unpack this statement.

A variable interest rate means that the bank can change the interest rate at any point in the future. A bank will tend to offer higher interest rates when the economy is doing well and lower interest rates when it’s doing worse.

The last ten years since the financial crisis have seen record low rates, and experts don’t expect this to change any time soon. This is why the interest rates on offer tend to be so low, in turn meaning that most savings accounts don’t offer an interest rate about the rate of inflation. So even though you’re earning some interest, ultimately the last few years have produced higher inflation than the average bank savings interest rate, meaning that money is being lost in real terms.

There are some positives, however. The biggest benefit of holding your money in a savings account is that you can easily access your money at any time. This means that if your savings act as a rainy day fund, then a savings account will offer you the flexibility to access it at any time. As we’ve seen, however, the flexibility comes at a price.

Stock market 📈

A search for higher returns could take you to the stock market. Here you’ll be able to put your money into companies, with your future financial returns depend on the future stock price of that company.

Investing in stock markets can be risky, especially if it’s done with savings that you’re not willing to lose. This is because a decline in stock prices could reduce or even eliminate your savings in the future, rather than growing them. The upside of this risk is that they could grow vastly in the future, however, there is no guarantee for this.

In terms of being able to access your cash, this will depend on the liquidity of the market. If lots of people are looking to buy and sell your particular stock, you’ll easily be able to get rid of it or buy more. However, if nobody is looking to do either (which is unlikely with popular companies, but could be the case with smaller ones) then you may struggle to cash out your holdings.

The stock market certainly provides some great opportunities for future growth, however, the inherent uncertainty of it means that it’s not a place we recommend putting your savings if it’s money you’re not comfortable risking.

Fixed incomes 🛡️

SSo how can we get a guaranteed interest rate that beats inflation in the future? Fixed income products offer a great option. By its very definition, a fixed income will provide a regular income set at a particular figure, without variation.

Bonds

The most common example of this is a bond. Governments and companies issue bonds for a specific period of time (ranging from a few months to a few decades) with a specified interest rate for the period.

When these institutions issue a bond, they are essentially loaning money from you and promising to pay you for that money over the set period of time.

Government bonds like those from the US or the UK tend to offer very low-interest rates. This is because they are seen as such safe investments (it’s very unlikely that either would fail to pay back the loan) that they can offer lower interest rates when they need to borrow.

Corporate bonds can offer slightly higher rates but often also come with more risk. Unlike the UK government, it’s not so certain that they’ll be able to repay in the future.

Bonds offer a great low-risk fixed income opportunity, however, a final difficulty is how accessible they are to the normal investor. It’s quite difficult to buy bonds when they are newly issued, as big institutional investors mainly do this. This means that normal savers can only buy bonds on the secondary market, potentially getting less interest.

Fixed-rate accounts

So what do you do if you want a higher interest, fixed income and repayment guarantee?

One option could be to look at fixed-rate accounts. This financial tool allows you to lock your savings away for a specific period of time, usually a minimum of one year. Through committing your money for this period you will be offered a higher interest rate.

If you’re happy not to think about that money for a year, it’s a great option. You’ll be provided with a guaranteed interest rate that you know will be there when the period expires. The downside is that if you need to access this money, it’s likely you’ll not able to get your money back before the agreed date.

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