Where do you keep your money? In a savings account, ISA or maybe in a box under your bed?
No matter where you keep your savings, if the interest rate is below inflation (which almost all of them currently are) then the buying power of your savings will gradually decrease.
Your savings are losing value.
Why interest rates matter
65% of UK adults do not know the definition of an interest rate, according to research from Money Supermarket.
Meanwhile, 57% do not know the current Bank of England (BoE) base rate has recently been increased in a bid to combat relatively high inflation rates.
What are interest rates and inflation, and how do they affect you?
Interest rate: The return you will see on your savings. This is the percentage you will see on your account information. If you don’t know yours, you can find it on the bank or building society website, by ringing them or visiting a branch in person.
Inflation: This shows how much the cost of living has increased over the past year. This is calculated using the cost of a hypothetical ‘basket of goods’ which is compared to the cost of the same basket one-year prior. The items used in this process are updated annually to reflect current society.
When inflation is higher than your interest rate, it means that the cost of living is increasing faster than the value of your savings. This in turn, affects your buying power; you can buy less now than you could have a year ago, with the same amount of money.
To combat this, your money needs to be producing real returns, where the interest rate is higher than inflation.
To do that, you need to weigh up the available options and find one (or a mix) to suit your needs.
Saving vs investing
The decision to save or invest depends on a variety of factors, including:
How much time you have to achieve your goals: If you are saving for a short-term goal, or for a purpose which could require instant access to funds, then Cash savings are probably most appropriate as the capital value can’t fall. However, if you are saving for the future, such as retirement, then you may wish to opt for the riskier option of investing, as long-term investments are more likely to produce returns. However, it is important to remember that nothing is guaranteed when investing, and you could get back less than you put in.
Your attitude to risk: If you are looking to limit the possibility of losing capital, then a Cash savings account is likely to suit your needs better. However, if you are willing to take more risks for potentially higher returns, investing may be for you.
Your capacity for losing money: If you want to put spare money to work, but will not be negatively affected by potential losses, you could find that investing works for you. But, if you know you will be relying on these savings in the future, it is wise to keep it safe from potential losses in savings.
What are the alternatives if you want to beat inflation?
There are a range of options available for different savings goals and purposes. The most effective way to make sure that you are making the right decision (apart from asking an independent financial adviser) is to educate yourself on the ins and outs of the accounts available:
Individual Saving Accounts, or ISAs, are a tax-free saving vehicle which come in a variety of shapes and sizes to suit people at different stages of life. The most common ISA types include:
Junior ISA: An account designed for those under the age of 16 and available in both Cash and Stocks & Shares account types. It must be managed by an adult until the child reaches 16, but the cash cannot be accessed by them until they turn 18. The annual limit for a Junior ISA will be £4,260 for the 2018/19 tax year. A Junior ISA is not available for a child who already has a Child Trust Fund.
Help to buy ISA: Available from the age of 16 and offers a 25% government bonus on savings between £1,600 and £12,000. Contributions are limited to a maximum of £1,200 in the first month and £200 in each following month. A maximum of £3,600 can be saved into a Help to buy ISA each year, which contributes toward your annual ISA allowance of £20,000.
Lifetime ISA: Lifetime ISAs can be opened by those aged 18 to 39, to deposit up to £4,000 each year. This is then subject to a 25% government bonus. Money can be withdrawn without penalty, if it is to be used as a deposit on the holder’s first home, or as retirement income after the age of 60.
Stocks & Shares ISA: This account allows you to invest your saving deposits. As with all investments, this will incur risk, but for long-term savings, it could produce higher returns that the interest rates offered by banks and building societies.
Innovative Finance ISA: This account type allows you to invest your savings in peer-to-peer loan arrangements. It carries an element of risk but has been known to provide returns which are above the average interest rate.
Cash ISA: An adult Cash ISA can be used to hold savings which you do not want to risk losing in investments. The money held in this account will benefit from interest but is currently unlikely to see above-inflation returns.
Challenger banks are smaller companies who are trying to break into the finance sector. While they do not have the reach and influence of most high street banks and building societies, they are able to offer more specialised and personal service, with better technology, as they are unencumbered by the baggage of older organisations. In addition, Challenger Banks offer higher interest rates to make up for a less-recognisable brand.
Governed by Sharia Law, Islamic Banks are prohibited from charging or paying interest on savings. Instead of an interest rate, Islamic banks provide a target profit rate, which can be met through the sharing of profits, rather than paying of interest.
Islamic banks offer products which are much like those seen in traditional banks, including regular saving accounts and fixed-term deposit accounts. With target profit rates generally above comparable interest rates they could be a viable alternative to your current bank or building society.
Before settling on a Challenger Bank or Islamic bank, you should check whether your deposits with that company will be covered by the Financial Services Compensation Scheme (FSCS). The Financial Conduct Authority (FCA) register gives more information about individual organisation’s protection status.
Government Bonds are offered by National Savings and Investments (NS&I), the Bonds which are suitable for savers include:
Guaranteed Income Bonds: Your money is held for one or three years and a fixed rate of interest is paid directly to you each month.
Guaranteed Growth Bonds: Your money is held for one or three years and a fixed rate of interest is added to it each month, meaning that growth gradually increases.
Investment Guaranteed Growth Bonds: This is the same as Guaranteed growth bonds, but you can manage and invest your savings online.
Premium Bonds: These do not pay interest, but every pound grants you a single entry into a monthly prize draw. Prizes of £25 to £1 million are available but winning is not guaranteed and your savings may never increase.
You may also wish to consider corporate or property bonds. This is effectively lending your money to a business or individual. And, whilst you may see a higher return, they do come with a sizeable risk of losing money.
Beware of scams
Whilst looking for the best returns on your savings, you may come across deals which seem to answer all your problems. However, remember the golden rule of finance; if it sounds too good to be true, it usually is. There are many people and groups looking to take advantage of vulnerable savers, so make sure that you check any offers twice.
The FCA regulates many financial organisations and is a good place to start if you think you may have been contacted by a potential scammer.
For more information, get in touch with Bev or Sarah on 0115 933 8433.