Inflation and investing - will the banks rip us off even more now?

Many people in the UK think that investing is 'risky'. This is true if you invest in a few individual companies, but a global index tracker fund is not risky in the long term - it is just more volatile than a savings account (but far more rewarding!).

Even Government bonds are no longer perceived as entirely risk-free assets - their long-term growth potential is now in doubt if you consider inflation too. 

In this article, I also discuss a UK index ETF that has returned an average of 17% each year over the last 5 years, gives over 4% in dividends each year and did NOT lose you money in 2022!

Using a savings account is not risk free - you could actually lose money in real terms if inflation exceeds the savings rate. Currently, the UK inflation rate is around 3.6% and the savings rate is around 4.3% (and due to go down soon), so the effective rate of return before tax is 0.7%. If you make more that £1000 a year however, you will have to pay income tax of at least 20% on that 4.3%, so that reduces the real savings rate gain to 3.4% which is less than the current inflation rate. So many people with over approx. 20k in savings will start to lose money by using a savings account - unless they use a cash ISA.

'Rachel from accounts' seems to think it is a good idea to relax regulations and get banks to prompt their customers towards investment accounts. Several UK banks offer investment accounts, including Barclays, Lloyds, Halifax, HSBC, and Santander. I am sure they will be delighted to charge their customers for the privilege of opening a new investment account and giving them their money!

These banks and others will start to formulate 'simple' investment products for the masses which will, no doubt, have a healthy TER of 1-2% and probably invest in the FTSE 100 (like VUKG, approx 0.1% TER) as well as Money Market Fund wrapper products. The poor old ignorant consumer will still not realise that they can simply open a free S&S ISA account (with Trading 212 or Invest Engine for instance) and only pay a TER of as low as 0.12%-0.15% for a global fund such as ACWI or HMWS, and also invest cheaply in the FTSE 100, S&P 500 and NASDAQ 100 too.

The Vanguard FTSE 100 VUKG has shown reasonable performance and did not go negative in 2022 unlike most other indexes in that year! It has easily averaged over 10%+ over the last 5 years - compare this to the Cash ISA rates which have fluctuated between 1% to 5% in that time, even if you fixed.

AJ Bell's director of public policy Tom Selby said "A starting point on the road toward simplification should involve merging Cash and Stocks and Shares ISAs, ending the arbitrary distinction between the two to create a unified ISA product serving the needs of the vast majority of ordinary people."

I totally agree with this. 

The Canadian TFSA

The Canadians have a TFSA - A Tax-Free Savings Account (TFSA) is a Canadian investment account that allows individuals to save or invest money without paying taxes on any investment income or capital gains earned within the account. So it is basically like a flexible cash ISA and a flexible S&S ISA in a single tax free wrapper.

Unlike our ISA system where we are allowed a maximum contribution each year but that allowance expires after April 5th each year (use it or lose it), the TFSA contribution room is the total amount of all of the following:

• the TFSA dollar limit of the current year (e.g. C$7000 for 2025)
• any unused TFSA contribution room from previous years (may vary each year)
• any withdrawals made from the TFSA in the previous year

i.e. every Canadian will want to open a TFSA as soon as they turn 18 because their allowance will build up over the years even if they have no money to put in for the first few years.

The advantage of this system is that someone may benefit from a sudden 'windfall' (e.g. inheritance or pay bonus) and may well be able to put the entire amount into a TFSA if they have a large unused 'contribution room' built up.

With the UK ISA system, if we inherit say £50k, we can only put £20k into an ISA immediately but will have to wait until the following year to add another £20k and then next year to add the final £10k.

The downside of the TFSA is that it makes it quite complicated to know what your contribution room is. If you accidentally exceed the limit, there is a tax penalty.

The future for UK savings

I don't see us adopting the Canadian system (unless it is a new scheme for UK shares only?), but I do think banks will start to suggest to their cash ISA customers that they consider switching to the bank's own MMF and 'simple' index funds inside an S&S ISA - and of course charge them a fee for this.

Government regulation on financial advice will be relaxed to allow this, but we really need better financial/investment education in the UK and we need to make financial and investing products easy to understand.

UK Taxes

I believe that we should keep income tax as low as possible but increase taxes on spending (e.g. VAT). This gives people the choice of either saving, investing or spending their hard-earned money. If they have no money left to save or invest at the end of each month, they are just going to spend what little they have left on a well deserved treat to give themselves a little reward - saving seems hardly worth it as it barely keeps up with inflation.

At the moment, if we go to a restaurant, or buy goods such as toys, electronics, cars, etc. or buy services, they have VAT added at 20% - but there are many strange anomalies:

• Why are most financial services zero rated for VAT?
• Why are UK private schools now subject to VAT but private health firms are not?
• Alcohol and tobacco are bad for our health and are both taxed but highly processed food is not subject to tax or VAT (though there is a sugar tax on some products)?
• Why are cakes zero-rated for VAT but biscuits are not?
• Why is hot, freshly baked food zero-rated for VAT but the same food, if kept hot, has a 20% VAT charge applied?
• Why is good honest hard work taxed at 20% (40% higher rate of income tax) but capital gains from holding shares taxed at 18% (24% higher rate)? So people earning £50k+ pay 40% on anything they earn above £50k each year, but they pay only 24% on capital gains only when they sell even though they have done no work for that gain? It is almost as if the rich have tweaked the rules to benefit themselves whilst penalising the people that actually provide essential goods and services and build our UK infrastructure. Where is the incentive for the average working person to work harder, improve themselves and be more productive?

How will Rachel's proposed changes affect UK shares?

Banks currently invest some of the cash that is inside cash ISAs into government bonds, corporate bonds, or other securities to generate returns. Of course, they deduct their fees and overheads too. Changing the cash ISA rules may thus have the effect of moving money out of government bonds and other UK securities (pension funds).

UK Financial institutions will take advantage of Rachel Reeve's proposed relaxation of rules and code of conduct changes to encourage people who have large amounts (>£10k?) in their current, savings and cash ISAs, to think about investing. Thanks to government digitalisation changes, financial institutions will be able to determine if their customers already have ISAs on other platforms and AI can be used to suggest an appropriate product for each of their customers.

I am always very wary whenever a government relaxes rules, regulations and codes of practice which will have been put in place for good reasons. My 'Spidey Senses' start to tingle. I mean what could possibly go wrong (e.g. Lehman brothers, HBOS, Enron, Deutsche Bank, Royal Bank of Scotland, BlackRock, etc.)?

Also, why are we in the UK are all paying £100s more for electricity a year than we should? It's because of government deregulation - see here. If electricity was cheaper, there would be no need for expensive green, net zero government incentives (i.e. wasting the tax payers money).

We could see yet another round of mis-selling lawsuits if this is not handled carefully, but meanwhile we should see more cash going into the FTSE, UK banks getting richer as well as the wider stock market and less £cash being 'wasted' sitting in current accounts, savings accounts and cash ISAs.

It is disappointing that up until now, my favourite consumer hero, Martin Lewis who founded
www.moneysavingexpert.com, has always avoided any topic involving investing. However, he may be dragged into this area if we start to see simple investment products offered by banks and building societies. This would be a good thing as he can then educate a lot more people on the benefits of investing

P.S. Martin Lewis has just released a new BBC podcast today on cash ISAs and investing - I must be psychic! He did however make a small factual mistake (hint: what he said about the FTSE 250 was incorrect - it is a mid-cap index which comprises the 101st to 350th biggest companies not first 250 companies).

For me, it is too early to start investing into UK banks, but I am watching carefully.

I must admit that I was rather surprised by the performance of the Invesco FTSE 100 RAFI fund PSRU

PSRU is a distributing fund (quarterly dividends - approx 4%/yr) but has provided steady growth over the last 5 years (avg. 17%/yr). 

PSRU is certainly not as volatile as the NASDAQ 100 (-34% in 2022!) or S&P 500 (-8% in 2022), so if I wanted to invest in the UK and have dividends too, PSRU seems a better horse than say VKUG (acc) despite the higher TER of 0.39% for PSRU - and it is far less volatile than US indexes.

For cautious UK investors, PSRU would not be a bad choice.

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I find the YT videos by Richard Murphy very informative. I agree with most of what he says (but not all!).