Why interest rate rises still don’t mean “cash is king” when it comes to your savings

We find ourselves in unusually volatile times. The conflation of a global pandemic, a European war, and the economy teetering on the brink of the third recession of this millennium means you might be concerned about your financial security.

It’s at times like this that your emergency fund can be so valuable. Keeping three to six months’ expenditure in an easy access account is a core part of your financial plan – precisely for uncertain periods where you might need it in a pinch.

However, if you hold cash savings that you’re not planning to use for a few years, the current spike in inflation means that your money is likely losing value in real terms – even though interest rates are rising. Read on to find out more.

What is inflation and why is it so high?

Inflation is the rate of increase in prices over a given period.

There are several economic measurements used to judge the rate of inflation, one of the main ones being the Consumer Price Index (CPI). The CPI measures approximately 180,000 price changes in a hypothetical “basket” of goods and services, that is weighted against consumer spending patterns, in order to produce their monthly index.

Inflation is currently on the rise due to a variety of global factors including the disruption to supply chains and production caused by the pandemic, and the impact on energy prices of the war in Ukraine.

What is inflation currently and how does it hit my wallet?

According to the Office for National Statistics, inflation in the UK stood at 9.1% in the year to May 2022, reaching its highest level in 40 years. Experts predict that is likely to rise again this year.

In simple terms, the cost of £100 of goods and services a year ago will, on average, now cost £109.10. If you apply that same of level of price rises to your monthly and annual outgoings, you can really start to see the impact of inflation on your spending.

• According to Bloomberg, UK petrol prices have reached a record high, as the cost of filling the average family car has exceeded £100 for the first time. The price of fuel is expected to continue to rise.
• The latest Ofgem report shows that UK energy bills have soared in 2022, as the price cap was increased by £693 or 54% this past April, heavily impacting the average UK household’s monthly outgoings. The Guardian reports that it is expected to go up again in the autumn.
• The Guardian also reports that grocery prices have risen by over 20% on certain product lines.

If you have cash savings, it’s likely that they won’t be keeping pace with the rising cost of living, even though the Bank of England increased the base rate of interest to 1.25% this month.

That’s because, according to Moneyfacts, the best interest rate on an easy access savings account (as of 23 June 2022) is 1.56%.

This means that if you had set aside £10,000 in savings a year ago at an interest rate of 1.56%, you’d have £10,156 today. However, £10,000 worth of goods and services a year ago now costs, on average, £10,910 (at 9.1% inflation).

Even though your savings have grown by £156, the reduced value in real terms of those savings means that you can buy less with them than you could a year ago.

What can you do to protect your cash against inflation?

Shop around for the best interest rate

Your next steps are largely determined by your own financial aims and the timescale with which you’re viewing your potential savings.

If you are looking at your savings in the short term (less than five years), then you should focus on small changes such as reviewing the type of savings account you have and if it is giving you the best rate of interest.

For example, choosing a one- or two-year fixed-rate bond might provide a better return than leaving your cash in a high street instant saver account.

However, even the best savings account won’t currently pay a rate of interest that keeps up with inflation. So, if you have set aside excess savings beyond your emergency fund, and want to take a long-term view, then it could be beneficial to consider investing instead.

Consider investing your spare cash

If you have at least three months of funds set aside for essential bills, and you don’t plan on accessing your cash for five years or more, then you might want to consider investing your excess cash.

While investing typically comes with an element of risk, it’s instructive to look back to see the potential benefits of investing over saving your excess cash.

IG analysed returns on FTSE 100 investments between 1984 and 2019 and found annual median returns of 8.39% (five-year period), 7.39% (10 years) and 8.13% (25 years).

While the value of your investment can go down as well as up and you may not get back the full amount you invested, and past performance is not a reliable indicator of future performance, investing can give your money the potential to keep pace with inflation.

We can help create a diversified portfolio that aligns with your risk profile.

Overpay on your debts

Rising inflation means interest rates are likely to continue to rise. Therefore, it may be beneficial to consider overpaying on any mortgage or loan repayments at the present time, while interest rates are still relatively low compared to historic levels.

If the interest you’re paying on debt is higher than the interest you’re receiving on your savings, it could be beneficial in the long term to pay down this debt. Don’t forget to keep an emergency fund, though.

Seek tax benefits

Another way of making sure your savings are being managed effectively is to ensure they are performing as tax-efficiently as possible.

ISAs exempt you from Capital Gains Tax or Income Tax on anything you put in up to the £20,000 threshold (2022/23 tax year).

And, if you choose to move savings into your pension, then you could receive Income Tax relief of up to 45% dependent on your marginal tax rate. Remember though that you can’t normally access your pension savings until age 55 (rising to age 57 in 2028).

Get in touch

Making the right choices for your savings during times of high inflation can be a complicated process. Seeking professional advice is often the best first step on the road to a secure future.

If you need us, you can email us at enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.

Please note

The value of your investment 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.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.