The Bank of England recently cut interest rates from 4.75% to 4.5%, which is their lowest level for the past 18 months. Many people are unaware of the hidden cost of holding cash and the fact that it could be hindering your savings. In this blog, we look at how inflation erodes cash savings and investment strategies to make your money work harder for you.
It is the third interest rate cut to date since August 2024. If you have low-interest cash savings, you are less likely to see good returns as interest rates continue to fall. Many savings accounts are not index-linked to inflation, which means they don’t keep up with interest rate changes. And interest on cash savings is usually lower than the rate of inflation.
How inflation erodes cash savings
As well as affecting the cost of the things we buy, inflation can reduce the value of your savings, too. The rate of inflation affects prices – for example, 10% inflation means that a £1 product will cost £1.10 instead. The product hasn’t changed but it costs more, and the same applies to your household spend, such as energy, food and fuel bills.
When it comes to low-interest cash savings, as the cost of living increases, inflation begins to erode your money. If you have £1,000 saved in a low-interest account for many years, this figure will stay roughly the same. But as inflation rises, your money’s buying power decreases. Using a 10% inflation rate, an item that cost £1,000 last year now costs £1,100 this year. Or, if you look at this another way, your £1,000 savings are now only worth £900.
According to Legal & General, 52% of savers are unaware of the impact of inflation when it comes to low-interest accounts. They estimate that when inflation is 6% for 5 years, people could lose an average of £243 for every £1,000 in cash savings. Over a period of 13 years, their savings would therefore be halved, should inflation stay at this same rate.
How to find the right balance between cash reserves and investments
Disinvesting when markets are low and reinvesting when markets are high is a common trap people can find themselves in. One of our financial planners met with a client who had disinvested a couple of years ago. At the time, markets were low and volatile while interest was high, and now they are not getting as good a return on their savings.
When our financial planner had originally modelled their savings and suggested they could be worse off, this couple thought they knew best and turned to cash. However, now they have seen what can happen by taking a cash approach, they have asked us to manage their savings again.
Our real-life example highlights the importance of receiving professional financial planning advice and seeing investments as a long-term strategy.
Investment strategies to make your money work for you
There are various ways to make your money work harder through investments and to generate better returns. Your approach will depend on your chosen level of risk.
- Take a long-term approach to your investment strategy – markets will rise and fall, which will affect the value of your investments. Unless you need access to cash sooner, aim to invest for at least 5 years.
- Diversify your investment portfolio – spreading your portfolio across different types of assets will help to protect your investments from market volatility. Find a simple, low-cost investment portfolio that’s tracked against other elements of global markets.
- Consider transferring some Cash ISA funds into a Stocks and Shares ISA – if you plan to hold money in an account for more than 5 years, then this could be a suitable option. You can save in both types of ISA as long as you don’t exceed the annual allowance. Make the most of your allowances before the end of the tax year.
- Make sure your investments are tax-efficient – there are various ways to make your money more tax-efficient, for example, ISAs allow you to save tax-free. Check that you are utilising all available tax allowances, which includes your pension savings.
- Keep some cash handy for an emergency – don’t get rid of all your cash savings in case you need fast access to money, or you need to cash in your investments. It’s recommended to have enough money to cover your outgoings for at least 6 months.
Chartered Financial Planner, Nottingham and Lincoln
As we approach the end of the financial year, it’s important to check that you have a tax-efficient approach to your savings and investments. Make use of all available tax-free allowances, and check that you are on track with your current financial plan.
If you don’t have a financial plan or your circumstances have changed and it’s now outdated, speak to our financial planners. We will review your current savings and investments strategy, and we’ll use sophisticated cash-modelling software to determine a suitable approach. Our aim is to help you achieve your goals with a sensible financial plan.
For a financial review of your savings and investments, get in touch with our financial planning team.
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