The last decade has been a tough one for savers. Record low interest rates have made it tough to generate much of a return on cash savings, with the Telegraph reporting that nearly £1 trillion of savings is languishing in easy access accounts paying an average rate of just 0.18%.
Now that the Bank of England has raised interest rates six times since December 2021, you may think that, finally, rates on cash savings are starting to improve.
Whilst that is true, there are several reasons why leaving your surplus cash in the bank could be riskier than you think. Here are three of the most important.
1. High inflation can erode its real value
According to the latest Office for National Statistics (ONS) data, the inflation rate in the UK hit a 40-year high of 9.4% in the year to June.
Effectively, goods and services that cost you £1,000 a year ago will cost £1,094 today. You’ve probably already noticed the impact at the pump or your favourite restaurant.
Whilst interest rates on cash savings may be rising, even the best rates currently fail to keep up with the rising cost of living.
According to analysts Moneyfacts, as of 15 August 2022 the best easy access savings account paid 1.67%. Had you invested £100,000 a year ago, at that rate you’d now have £101,670.
Compare this to how the average price of goods and services has risen from £100,000 to £109,400 in the same period. This clearly shows how saving in cash has reduced your spending power and eroded the value of your wealth in real terms.
2. Returns are likely to be inferior to investing
Keeping some wealth in cash is a core part of a financial plan. Whether it’s your emergency fund or you’ve earmarked it for use in the next year or two, there are many sound reasons for holding cash.
However, keeping too much in cash could be a risk if it slows your progress towards your financial goals.
Much of the growth that powers your financial plan comes from higher-risk assets such as equities. So, keeping too much in cash could see you miss out on more positive returns.
The table below compares the returns of investing in the UK stock market (as represented by the FTSE All-Share Index) with dividends reinvested, and the returns on investing in cash deposits with the interest reinvested, between 31 December 1999 and 31 March 2022.
Source: FE fundinfo. Data as at 31 March 2022.
Of course, the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
However, this shows that even during periods of volatility – such as the dot-com bubble, the global financial crisis, and the Covid-19 outbreak – the returns on equities outpaced that of cash.
Interestingly, had you moved your savings from cash and invested them in equities at precisely the worst time, on the eve of the financial crisis in October 2007, you would still have generated better returns in the long-term.
Whilst you would have suffered an initial 46% loss in the first 17 months (and probably regularly rued your decision to invest!), by January 2013 the value of the investment in UK equities had not only recovered completely but had also overtaken what you would have earned in cash deposits.
And, to the end of March 2022, that same equity investment made at the peak of the market in 2007 would have delivered a gain of 104%; whereas cash in the bank would have provided a cumulative return of just 16%.
3. Protection is limited by the Financial Services Compensation Scheme
A final risk of holding too much wealth in cash is that there is a limit to the amount of protection afforded to your savings by the Financial Services Compensation Scheme (FSCS).
As of August 2022, the FSCS will automatically compensate each eligible individual up to £85,000 if you hold money with a UK-authorised bank, building society or credit union that fails. There are temporary higher limits of protection in specific cases, for example money paid as the result of a property transaction.
So, if you have more than £85,000 with a single institution – and remember that some banking licences include several brands, such as HSBC and First Direct – your savings could be at risk if the organisation fails.
In this instance it can pay to spread your savings across a range of institutions to ensure you maximise your FSCS protection.
Get in touch
If you’d like to have a chat about how to maximise the return from your cash savings, please get in touch. Email or contact us on 020 7400 4700.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.