Since the start of the financial crisis in 2008, savers have had to content with all-time low interest rates and periods of relatively high inflation, but just when savers thought things couldn’t get any worse they have been hit by a double blow.
Firstly interest rates on savings accounts have started to fall again as banks and building societies reduce their best savings interest rates after the introduction of the government’s Funding for Lending Scheme (FLS).
Secondly, inflation has again shown signs of starting to rise more rapidly, with many experts predicting a return to relatively high levels of inflation in 2013.
Why is the Funding for Lending Scheme affecting savings interest rates?
It’s perhaps not obvious why the best savings interest rates have fallen after the FLS was launched, so let us try and explain.
Banks and building societies have traditionally had two ways of raising funds, which they then lend out to borrowers in the forms of loans and mortgages. Firstly they have the wholesale market, in other words, other banks, and secondly they use the deposits made by savers.
Put simply, they offer savers a rate of interest, charge borrowers a higher rate, and the difference, less costs of course, is profit.
The FLS has allowed banks and building societies to borrow money from the government at a far lower rate than is possible on the wholesale market. This has meant they have been less interested in attracting money from savers and have therefore been able to reduce the interest rates they pay.
Because competition for savers has decreased even banks and building societies, that have not joined the FLS, have been able to reduce interest rates on their savings accounts.
How far have interest rates fallen?
The financial information provider, Moneyfacts, has reported that since the introduction of the FLS:
- The average interest rates on instant access savings accounts have fallen from 1.08% to 0.96%
- The average interest rate on one year fixed rate bonds has fallen by 0.5% to 2.24%
- The average interest rate on fixed rate Cash ISAs (Individual Savings Accounts) has fallen from 2.82% to 2.42%
Other savings accounts have simply been withdrawn altogether.
What can you do to protect your savings?
So, with interest rates falling and inflation possibly on the rise, what can you do to protect your hard earned savings?
Use your Cash ISA allowance. Everyone can save up to £5,640 in a Cash ISA in the current tax year (£5,760 in the 2013/14 tax year). The main advantage of a Cash ISA is that no tax is deducted from the interest you receive, giving you a higher return.
Sure, with interest rates so low you won’t save much tax, but the benefit builds up. A husband and wife paying the maximum amount possible into a Cash ISA each year for 10 years, would have well over £100,000 sheltered from tax.
For the best rates of interest consider a fixed rate Cash ISA, although remember you will tie up your savings, probably without access, or an instant access Cash ISA offering an initial bonus rate of interest (see below).
Saving for your children? Use a Junior Cash ISA Most children don’t pay tax so the benefit of a Junior Cash ISA can be limited. However, if you are saving for your children’s future in your own name and are a tax payer, consider whether you would be better taking advantage of a Junior Cash ISA.
Each child, parent, or grandparent, can pay up to £3,600 per year into a Junior Cash ISA sheltering the interest from tax. This might be more tax efficient that holding savings for your children in your own name, be careful though, at 18 your child can access the savings without your permission.
Shop about This might sound obvious, but far from everyone shops around for the best savings interest rates, often leaving large sums of money languishing in accounts paying poor rates of interest.
Be ruthless, ditch any accounts not paying a competitive rate and move to an alternative bank or building society. Then regularly check that interest rates have not been cut, banks and building societies don’t have to write to you when they reduce rates and it’s easy to miss rate reductions.
Remember though, when it comes to Cash ISAs, don’t cancel accounts, transfer them, otherwise you will lose the tax benefits from previous years.
Take advantage of bonus rates. Many of the best buy savings accounts offer bonus interest rates, to attract new customers. Taking advantage of these bonus rates can be an excellent way of boosting the return you receive.
Remember though, when the bonus period comes to an end, the on-going interest rate can be far from attractive, its therefore important to make a note of when the bonus is removed and consider shopping about again.
Consider longer term fixed rates. As a general rule of thumb, the longer you are prepared to tie up the savings the more you will be rewarded with a higher rate of interest. Simply put, a five year fixed rate bond will pay more interest than a one year fixed rate bond.
Having said that, with interest rates so low and inflation possibly on the rise, many people are shying away from long term fixed rates, nervous that they could be tied into uncompetitive long term deals as and when interest rates start to rise again.
Repay debt. Although interest rates for mortgage are low, those charged for unsecured borrowing, especially credit cards, still remain relatively high. It makes no sense to be paying 17% or 18% on your credit card and be getting 2% or 3% on your savings.
If you have unsecured debt consider paying it off, although don’t leave yourself short in the event of an emergency.
Invest rather than save? If you are prepared to accept some risk to your capital you could consider investing rather than saving. Investments into stocks and shares, or other assets such as corporate bonds or gilts, are generally done by buying funds.
Such funds carry risk and the value of your capital could fall, which is not possible with a savings account. However, over the longer term, and with careful management, you should see a better return from investing than saving; although this is far from guaranteed and you may have to put up with some bumps on the road!
The FLS is here to stay, indeed there has already been talk about extending it and inflation is the enemy of all savers.
We can see no reason why it will get any easier for savers to get a real return on their money as we move into 2013; it’s therefore down to you to work your savings hard, whilst following our tips, to get the best return possible.
Our best buy savings tables are available online and are free to use. If you need more help, our team of Independent Financial Advisers in Nottingham are experienced in making savings and investments work harder for you.