Is Cash Still King?
Interest rates on savings accounts have remained stubbornly low for some long time now, according to Money Saving Expert, the best unrestricted, instant access account is paying just 1.25% per annum before tax (1.00% to a Basic Rate Taxpayer and 0.75% to a Higher Rate Taxpayer).
National Savings & Investments, where there are no Financial Services Compensation Scheme (FSCS) issues, pays 0.70% per annum before tax on their Direct Saver account.
Why have interest rates collapsed?
Why has this happened relatively recently when the Bank of England held rates at just 0.50% from 05 March 2009 to 03 August 2016 (0.25% since)?
The answer is that following the collapse, or near collapse, of the banking sector in 2007/8, financial institutions were keen to rebuild their deposits and were prepared to pay over the odds. The reason they were able to do this was because they had failed to pass-on the reduction in general interest rates to their borrowers, including mortgagees and businesses. However, two things have happened since.
- The Government put pressure on the Banks and Building Societies to pass-on the general reduction in interest rates to mortgagees and businesses.
- To help stimulate the economy, the Government instructed the Bank of England to make loans available to Banks and Building Societies at just 1% per annum on the condition the money was used to support the mortgage market and/or businesses.
There is, therefore, no incentive for the Banks or Building Societies to offer higher rates to retail depositors – you and I – when a simple application to the Bank of England can produce as much money as they want at just 1% per annum!
How much longer will this continue?
There are many factors that impact the decisions made by the Bank of England’s Monetary Policy Committee when they meet on a monthly basis to consider interest rates, but, currently, there is no sign of them moving away from the historic low rates we are currently experiencing. Some forecasters are predicting a rise to 0.50% in February 2018 and a further rise to 0.75% 18-months later. However, this very much depends upon the state of the Economy at the time, which, of course, is very unpredictable as we await the impact of Brexit.
What is the impact of these reductions?
The key issue is that of inflation and the “real value” of money on deposit. If inflation averages just 2½% per annum, the value of the pound in your pocket reduces by one-quarter every 12-years. Even with interest accumulating, with rates as low as those currently available, particularly after tax, those balances are not keeping pace with inflation.
According to the Office for National Statistics, CPI (Consumer Price Inflation) was 2.7% per annum in June 2017 and RPI (Retail Price Inflation) 2.4%. However, is that your rate of inflation? The BBC has a very useful inflation calculator on its website, which can be very revealing in terms of what your true rate of inflation could be. Whichever way you look at it, interest rates are definitely not keeping pace with inflation.
People on lower incomes, especially Pensioners, tend to experience an elevated rate of inflation compared to people on higher incomes. The reason for this is that the items which tend to go up fastest represent a significantly higher proportion of the expenditure of someone on a lower income.
Certainly, in the recent past, gas, electricity and food prices have increased much faster than the general rate of inflation. Over the past few years, Council Tax increases have been limited, but, prior to the current economic crisis, this was another source of increased inflation and is looking likely to be so again in the future.
Although somewhat out-of-date, a Barclays Capital analysis in 2014 of the rate payable on the Nationwide InvestDirect Account adjusted that for RPI and this showed that, in real terms, the return had been as follows for the previous 7-years:
- 2008 -0.2%
- 2009 -2.1%
- 2010 -4.6%
- 2011 -4.6%
- 2012 -2.9%
- 2013 -2.5%
- 2014 -1.4%
What this meant was that £10,000 at the beginning of 2008 was worth £8,300.62 in real terms (the goods and services it could buy) by the end of 2014 with gross interest reinvested. Of course, Pensioners often have to withdraw the interest earned to supplement their pensions, in which case the loss of buying-power is even more pronounced.
What can you do?
The first point to make is that everyone should have a prudent cash reserve for known and unknown contingencies. How much that should be is highly personal, but I recommend between 3-months and a year of basic expenditure, plus any known requirements for, say, the next 3-years. This needs to be kept in cash on deposit in a fairly accessible form, keeping in mind the FSCS limit of £85,000 per depositor per financial institution.
Beyond this, there seems to be a strong case for considering some form of investment to achieve returns potentially better than inflation in the medium (3-years +) to longer (5-years +) term. This can be done without “throwing the baby out with the bath water” in terms of investment risk.
If you think you have too much in cash and want to consider investing some, then ask me today or complete the form below and I’ll give you a link to our risk profiling tool to start the advice process.