Risk-free investing Risk management
Risk-free investment can be affected by interest, tax and inflation
Factors affecting low risk investments
Investing is all about managing the risk; assessing risks taken against rewards earned. For many people, minimising the risk is the most important thing.
There are three key factors to take into account when considering risk-free savings: interest, tax and inflation.
Interest
The interest you earn on savings varies considerably, depending on, the type and size of investment, the length of time you are prepared to see your money tied up and how often you need to access your cash.
To compare rates, investors should always look at the annual equivalent rate (AER), which is the true rate of return. It assumes that you reinvest any interest you are paid monthly.
Tax
Headline interest rates tend to ignore tax and risk-free savers need to be very aware of this. Banks and building societies usually pay interest with tax deducted at the standard rate of 20%. Higher-rate taxpayers pay 40% tax.
Inflation
The interest you earn needs to keep pace with inflation otherwise, your capital's purchasing power will be erode - this is why putting your money under the mattress (however tempting) is to be avoided.
For a basic-rate taxpayer, with inflation at for example, 3.0%, this requires a minimum rate of 3.75% gross, and for a higher-rate taxpayer 5.0% gross. Your savings will grow only by the amount you beat this and only then if you reinvest the interest you receive.
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