Savings Defined
What are savings?
Savings are really the money that you put aside for a rainy day or sometimes for an emergency.
Why should I save?
The main reason for saving is that nobody else is going to do it for us. There are going to be times in life when we need some other money to fall back on. Maybe we are ill and our earnings have dried up, and so should save for that. Maybe we want to splurge on that big holiday or that the boiler has blown up and it needs to be fixed in a hurry.
How much should I save a month?
In terms of saving, the amount you could save each month is the $64,000 question, or maybe not quite that much. A good rule of thumb is the “80-20” rule. If you can put 20% of your income aside for future reasons, you're probably on course for a good financial career. Another way to look at it is half that, 10%. This is an old, medieval amount of money, usually called a tithe. Even today, some churches still do it where the churchgoers donate 10% of their income to the church and in the olden days, this saving is used to pay for the church steeple or for the barn where people could put their crops. So it's an ancient principle that works really well, “A” for 10%, and any more saving is a good start, too.
What is capital?
Capital is the amount of money that you start off with. It's your original sum of money that you already have that you're going invest or add savings to.
What is inflation?
Inflation is the effect of the price of goods going up. For example, a loaf of bread or a pint of milk today wouldn't cost the same amount of money in five, 10, 15, 20 years time. So inflation is the rate at which the price of goods goes up over time.
What is interest?
When dealing with savings, interest is the sum of money that gets added to your capital usually by an institution such as a bank or building society, so this is how your capital grows overtime by the addition of interest.
What is the base rate?
The base rate figure in relations to savings is a figure set by the Bank of England. The Monetary Policy Committee set the base rate on the second Thursday of every month. It is then the base for most other interest rates to follow. Most lenders will pay their mortgage rates to the base rates. If the base rate goes up, mortgage rates go up and savings accounts too. If the base rate goes down, you'll get less interest on your savings. The Bank of England sets it for institutions can follow.
What does 'gross' mean?
In savings, gross means a number before tax. For example, your gross salary is usually the amount that you're told when you take a job, but it's not the amount that you get to take home at the end of the year because tax gets taken off the gross figure.
What does 'net' mean?
Net is the figure after tax has been taken into account. For example, on a salary it's usually explained in gross terms annually, but what goes into your bank account every month is the net figure. That net figure is after income tax has been taken away.
What is the Annual Equivalent Rate (AER)?
The Annual Equivalent Rate, or AER, is the effect or the true effect of interest at the end of the year, including any regular savings that are put in. The AER is used to equalize rates, and usually, to avoid any tricks by institutions. For example, somebody might give you a high rate of interest for a few months to attract you to an account but then drop the rate thereafter. If all you saw was the initial high rate, you might be misled. The AER takes into account the initial high rate and the subsequent lower rate and averages it out so that you can compare the rates across institutions and accounts.
What is a fixed interest rate?
In savings, a fixed interest rate is where a set rate, for example, 5%, is given on an account for a set period of time, for example twelve months. This way you know exactly what you're going to get and for how long. A fixed rate is not normally going to be changed by any change in the bank base rate.
What is a variable interest rate?
A variable interest rate is a rate that will change over time. A variable interest rate will usually change if the bank base rate changes, but it may well just be that an institution changes the rate. You need to look out for variable interest rates on accounts that sometimes attract you in with a high interest rate, but can then drop in the future.
What is compounding?
Compounding is the effect of interest on interest on interest on interest. Compounding is how your money grows, exponentially, faster and faster over time. For example, if you had a hundred pounds and received an interest rate of ten percent, the next year you'd be getting interest on £110, not £100. The following year, you'd get £11 interest rather than 10, on 121, so it just keeps going up and up and you're savings keep growing.
What does 'guaranteed return' mean?
In savings, a guaranteed return is when, at outset, you can be absolutely certain of what you're going to get. However, with any account that advertises a guarantee of return, watch out for clauses. Guaranteed doesn't always mean guaranteed. For example, you may see a product that guarantees an income; this would fine in itself, but watch out that that income is not being guaranteed at the expense of your capital. If you are looking for a guarantee, make sure that the whole of your investment, income and capital, are guaranteed.
