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Sipps Pensions Exeter

Can seriously damage your wealth

A pensioner's lot is not a happy one and getting a lot less

Most economists openly acknowledge that pensioners are taking the brunt of the post 'Credit Crunch' attempts to stabilize the economy. Mortgage payers have been relatively protected from the worst economic downturn in living memory. Mortgage rates have been slashed to stop the housing market, which is the backbone of the UK economy, going into a tail spin. Although many homeowners are in negative equity, repossessions due to failure to pay the mortgage have been relatively low compared to the 1992 downturn.

The Bank of England [BoE] has been printing money to buy up gilts from the secondary market. This has caused increased demand for high quality fixed interest securities pushing up their price and driving down their income yield creating a 'Fixed Interest Bubble'.

These two issues alone make tip toeing though the investment minefield nerve-racking enough for even the most experienced investors let alone pensioners using their savings to top up their income. Hiding around the corner and out of sight is a silent and far more deadly factor, inflation! During what now seemed fairly normal times, interest rates from your saving accounts would have been broadly similar to the rate of inflation. This meant that the value of your pound in the bank would keep up with the increased cost of living providing you did not spend the interest.

The table below shows how the value of your pound has devalued over time. The Pound in your pocket in 1991 was worth only 77 pence in 2001. By 2011 the same pound could buy goods worth 57 pence back in 1991. Confused? Let's simplify it, if you had £100,000 in a bank account in 1991, unless it is worth £176,000 today you have lost value in your money.


Purchasing power of the pound 1991 – 2011

  1991 1996 2001 2006 2011
1991 100 114 130 148 176
1996 87 100 113 130 154
2001 77 88 100 114 136
2006 67 77 87 100 119
2011 57 65 74 84 100

Source: House of Commons Library, Inflation: The value of the pound 1750-2011 research paper 12/31


Magnified Inflation

Since 2008 we have seen the BoE base rate held at 0.5% with banks offering 1.5% to online savers and some offering as little as 2.2% inside cash ISAs with a two year tie in. Neither option is particularly attractive to someone needing income and access. Inflation has not been below the Treasury CPI target of 2.0% since Nov 2009 reaching 5.2% in September 2011. If inflation reaches 5.2% as before and interest rates are 1.5%, savers would be losing 3.7% per year before paying tax on the interest. Those that are dependent on the interest to top up their income, not only have less to spend now, but will also find that over the next few years the devaluation of their savings will accelerate.

So if you are concerned about any of the above, you should seek advice to reduce the effects of inflation before reading further.

That brings us to the future.

The new Governor of the BoE elect has already suggested that maybe we should look at the 2.0% inflation target whether it is still the right for today. Then there is the small matter of unwinding Quantitative Easing [money printing to you and me]. The simplest way to reduce the size of a mortgage in relation to your income is to increase your earnings.

Again let us bring it into a simpler form. Imagine you had a mortgage of £100,000 and an income of £25,000 per year. The mortgage equals four times your income. If we then managed to increase our income to £50,000 per year the same mortgage would be equal to only 2 years income and therefore easier to maintain the monthly interest payments.

Therefore the debt to income ratio has halved. For mortgage read National Debt and for income read Gross Domestic Product [GDP]

To do this in the UK, we need to stimulate the economy to inflate away the effect of the national debt. Normally to cool down inflation, we would see the BoE raise interest rates to cool inflation; however now they may wish to see a period of higher inflation to bring the national debt to a more manageable level relative to the UK's GDP.

You don't need any clues as to who will be worst affected by this……. PENSIONERS, who on fixed income will see the speed at which their cost of living is eroded, accelerate further.

Simply keeping your money in bank accounts is likely to see its value reduce even faster than before. Pensioners face a difficult choice between closing their eyes to inflation and pretending it does not affect them or seeking ownership investments, which have the potential to beat inflation.

We would not recommend that pensioners jump into the deep end of the equity markets or the new retail bond market; however working closely with a one of our investment managers on an advisory basis will help pensioners slowly build a portfolio and an understanding to help navigate them through their retirement.

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