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Peer2Peer Finance News | March 27, 2017

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Overcoming inflation

Overcoming inflation
Staff
  • On November 21, 2016

Inflation is eating away at paltry savings and cash ISA deals, yet it is the peer-to-peer sector that is often under the spotlight for putting money at risk. Can the sector change the narrative?

Behavioural scientists are constantly asking why people regularly do things that are bad for them. Despite all advice to the contrary, people continue to consume junk food, cigarettes and alcohol, and now this theory can be applied to their financial decisions as well.

Peer-to-peer platforms, regularly offering superior returns to traditional products, are increasingly fighting a battle to attract savers opting for mainstream savings accounts and cash ISAs which pay well below inflation.

Savers are currently facing a choice of low-paying accounts where inflation means they will effectively be guaranteed to lose money, or P2P products where the oft-cited lack of Financial Services Compensation Scheme (FSCS) protection means there is a chance they could make a loss, but no guarantee.

“While there may be a number of factors at play here, I suspect poor financial understanding and a lack of appreciation of the impact of inflation may be a contributory factor,” says Darren Duxbury, founder of the Behavioural Research Group at the Newcastle University Business School.

Data from comparison website Moneyfacts shows with consumer price inflation (CPI) at one per cent in September, just 252 out of 636 savings products paid above CPI.

So essentially savers are losing money sitting in at least 384 cash ISAs, savings or current accounts.

The inflation rate moved lower to 0.9 per cent in October, but many think this was a blip and the Bank of England estimates that inflation will hit 2.7 per cent in 2017, which could compound the situation for savers.

“If inflation continues to rise then savers’ cash will erode further as there are very few accounts that will provide a decent return right now,” explains Rachel Springall of Moneyfacts. “Savers would have to tie in for five years to get a two per cent return on a fixed rate bond, which shows how desperate times have become.

”P2P lenders have boomed in recent years and whilst these offer some headline-grabbing interest rates for savers – these deals are not without their risks. However, in difficult times a growing number of savers could well turn to P2P platform as a refuge for their cash.”

Savers who want safety along with a decent return are left in a tricky situation.

“With interest rates on savings languishing at historic lows, people face a difficult dilemma,” says a RateSetter spokesperson. “Deposits held with banks are safe and covered by the FSCS, but they are not protected from low interest rates or being eaten up by inflation.

“This means that when people use their savings in future, their money won’t go as far as it would today. For people looking to beat inflation, P2P lending may be worth a look. This is an investment so it carries some risk, but also offers higher returns.”

Data from industry analysts 4th Way shows that lenders on P2P platforms can get average returns in double figures depending on the platform they use and the amount of risk they are willing to take.

“P2P lending is like bread-and-butter bank lending, but with lower costs,” says Neil Faulkner, co-founder of 4th Way. “That is why it has also seen fantastic results against inflation since it started in 2005.

“As long as costs remain low, lenders can also expect to beat inflation in the vast majority of years, and certainly over the medium and long term.”

Faulkner adds that the roll-out of the Innovative Finance ISA will give the sector more respectability, particularly since it is associated with full authorisation from the Financial Conduct Authority.

Firms are already providing some form of lender protection to tackle the FSCS argument.
Many platforms such as RateSetter and Lending Works offer provision or safety funds that provide another layer of protection and security for clients.

So is it time to stop worrying about the lack of FSCS protection and focus on the inflation argument instead?

“The risks of P2P lending are not something we would ever want to undermine, and certainly it is important to us that consumers have a clear understanding of what’s involved when it comes to lending their hard-earned money,” says a spokesperson for Lending Works. “That said, it is also interesting to note that many people consider money in the bank as being a ‘safe’ option.

“If inflation forecasts for 2017 prove to be correct, or near enough to it, most – if not all – savings accounts and cash ISAs will earn interest below the level of inflation. The only ‘guarantee’ therefore is that savings will be diminished over time in real terms, other things being equal.

“It all means that P2P lending offers consumers a unique middle ground between savings and investments in terms of risk and reward, and therefore they can expect to earn returns well above the level of inflation with a high degree of confidence.”