Economics question

[MartinQ]

a) 1.025^10 - 1.02^10
b) 1.005^10 - 1

So yes. If the interest is taken, then there is no difference (without tax ...)

 

[nickyboy]

a) 1.025^10 - 1.02^10
b) 1.005^10 - 1

So yes. If the interest is taken, then there is no difference (without tax ...)

Maths is fine. But taking the interest removes the compounding effect of leaving it where it is. In that case, your effective Purchasing Power in the 2.0% inflation regime will be lower than in the 0.4% inflation regime

 

[SpokeyDokey]

For savers, is there a real difference between interest rates at 0.5% and inflation at 0% compared to interest rates at 2.5% and inflation at 2%?

That's a good question and tbh one I have never thought about and I like to think I have a really good grasp on my finances.

Maybe some smart maths enters the debate but without hitting the number crunch for me the latter scenario is more attractive - even in our powered down post-corporate career, zero debt, decent savings state we generate around 2.5 times more income than our expenditure so this works better in our household.

So I would say that for net savers the answer is yes.

 

[srw]

Maths is fine. But taking the interest removes the compounding effect of leaving it where it is. In that case, your effective Purchasing Power in the 2.0% inflation regime will be lower than in the 0.4% inflation regime

Taylor's expansion of the power series (or is it De Moivre's law - I could never remember the difference) says otherwise. For small i, (1+i)^x is near enough 1+ix, because i^2 and subsequent powers are immaterial.

I'll be near a spreadsheet tomorrow and might have a chance to do some sums to work out what's going on.

(Declaration of interest* - nearly 20 years ago I passed an exam specifically in compound interest. This sort of stuff was chapter 1 of the course. 3.5 years later I came out with a professional qualification where compound interest was at the heart of every subject. These days I have junior members of staff to do my difficult maths for me, but I'm still working in the same field.)

*bdum tish

 

[Flying Dodo]

Ok I think so. Bear with me:

0.5% of 100 = .5 less 20% tax = £0.40 less the 0% inflation = £0.40

2.5% of 100 = £2.50 less tax = £2 less the 2% inflation = 0.

I could be entirely wrong.

Slightly O/T, you can ignore the tax aspect as from 6th April 2016, all bank & building society interest will be paid gross and most people will have a £5,000 personal savings allowance, so any interest earned up to that amount will be free from tax.

 

[martint235]

Slightly O/T, you can ignore the tax aspect as from 6th April 2016, all bank & building society interest will be paid gross and most people will have a £5,000 personal savings allowance, so any interest earned up to that amount will be free from tax.

Useful to know. Now I just need to find some savings......

 

[vernon]

Ok I think so. Bear with me:

0.5% of 100 = .5 less 20% tax = £0.40 less the 0% inflation = £0.40

2.5% of 100 = £2.50 less tax = £2 less the 2% inflation = 0.

I could be entirely wrong.

Isn't interest below £1000 tax free for basic rate tax payers?

 

[martint235]

Isn't interest below £1000 tax free for basic rate tax payers?

I did caveat with "I could be entirely wrong"

 

[slowmotion]

Just buy bricks and mortar and forget about it.

 

[nickyboy]

I'll be near a spreadsheet tomorrow and might have a chance to do some sums to work out what's going on.

I'd be interested to see your maths. My perception is that unless you take the interest and then buy something with it that appreciates in value at the rate of inflation (ie faster in the 2.0% regime) which you can subsequently sell then spending the interest will result in lower effective Purchasing Power. However, I stand to be corrected

 

[Arrowfoot]

If it is framed as an economic question @User14044 gave the right answer. Savings in the past did a pretty decent job as a result of the then (1) higher prevailing savings rate, (2) then slower rising cost of living - this is different from inflation rate and the (3) the phenomenon of compounding.

Though the inflation rate was meant to mirror the cost of living, it has failed miserably. Hence the mover to various tracking indices including the now famous price of Big Mac.

Its the reason why people prefer to go BTLs, stocks and shares and other investment grade products. Folks are also known to upgrade their home and even move for that opportunity to increase equity.

 

[Milkfloat]

Slightly O/T, you can ignore the tax aspect as from 6th April 2016, all bank & building society interest will be paid gross and most people will have a £5,000 personal savings allowance, so any interest earned up to that amount will be free from tax.

£1,000 for basic tax payers, £500 for higher and £0 for additional, was my understanding. Has this changed?

 

[MichaelO]

I know there's a £5,000 tax free allowance for dividends coming in from April - which is available to all, even additional tax rate payers. Not sure whether that is what is being referred to?

 

[Flying Dodo]

Useful to know. Now I just need to find some savings......

Check down the side of your sofa.

 

[Flying Dodo]

£1,000 for basic tax payers, £500 for higher and £0 for additional, was my understanding. Has this changed?

Sorry - I wasn't being accurate enough, as there's a £5,000 allowance, but it not like a conventional allowance, in that it's not added to your personal allowance. You're quite correct - it means for a basic rate tax payer, you can receive up to £1,000 pa in interest and not have to pay tax on it. Higher rate earners, on anything up to £150,000 pa can receive up to £500 pa in interest and not have to pay tax on it, whilst anyone on more than £150,000 pa doesn't get any tax free interest.