One of the positive outcomes of the sharp rise to interest rates over the past two years is the opportunity to generate more interest on your cash savings. After many years of easy access savings interest rates hovering around the 0.1% mark, the new higher rates are certainly welcome by savers.
Indeed, it may be tempting to consider moving more of your wealth into cash given the guaranteed rate of return. Compared to investments such as equities, cash can often be seen as a “safe” place to store cash.
Cash isn’t exposed to risk in the same way as your investments, but that doesn’t mean there aren’t drawbacks to it. Read on to learn more.
Interest rates are at their highest in 15 years
The good news is that you can now achieve much higher interest rates on your cash savings than you might have been able to for the past 15 years.
The Bank of England (BoE) has raised the base rate 14 consecutive times* since December 2021, bringing it to 5.25% in August 2023. The base rate sets a precedent for high street banks in deciding what rates they can offer to their customers, which is the reason for the higher rates you’re seeing now.
Not all high street banks are passing on the full rate rises
Even though lots of providers are now offering interest rates of up to 5% on easy access savings accounts, not all banks are being quite so generous. Some of the larger high street banks are offering much lower rates.
According to the Financial Conduct Authority (FCA), some of the biggest high street banks had only passed on 28% of the interest rate rises to their customers between January 2022 and May 2023. In response, the FCA has created a 14-point plan to ensure that customers receive fair value from banks.
Even though the FCA plan could ensure that more banks pass on the higher interest rates to savers, it’s important to shop around to make sure you are getting the best possible rate.
Inflation could still reduce the buying power of your cash savings
Being able to get a higher interest rate on your savings is certainly a positive thing, but it’s important to remember that holding lots of your wealth in cash can still be risky. Over time, the buying power of your money could decrease if the interest rate isn’t keeping pace with inflation.
According to figures from the Office for National Statistics, inflation was 6.8% in the 12 months to July 2023*. Even though some cash accounts may be offering rates close to this, it’s highly unlikely that the rates will be able to keep pace with or outpace inflation over the long term.
This means that, over time, the buying power of your cash savings could reduce because prices rise more quickly than you can generate interest.
So, while cash savings can be a useful part of your financial plan, keeping all of your wealth in cash could harm your ability to meet your long-term financial goals.
Stock market investments may present more opportunities for your money to keep pace with inflation
Investing in the stock market does expose your money to some risk, as there is always a chance that you could get back less than you invested. But over the long term, historical data suggests that your money is more likely to be able to keep pace with, or outpace, inflation if it’s invested than if it is held in cash.
A report published by Schroders uses data from the past 96 years to demonstrate this point. As you can see from the graph below, the longer the time frame, the more likely stock market investments are to outperform cash when it comes to beating inflation.
Percentage of time periods where stocks and cash have beaten inflation, 1926 – 2022
It’s usually sensible to only invest money that you don’t need access to in the short term. Holding investments for a longer period of time, usually five years or more, gives your money more opportunity to recover from the natural fluctuations of the stock market.
Remember, though, that past performance isn’t a guide to future performance.
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If you’d like some guidance in choosing the most suitable ways to save or invest your money to help you achieve your long-term financial goals, please get in touch.
The value of your investments (and any income from them) 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. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
*Correct prior to September 21st, 2023.