Cash isn’t always king: the effect of inflation on cash savings

The 1st of October 1989 introduced a period of relatively lucrative and easy returns for those sitting on cash savings. With the UK base rate at 15%, those with bank cash savings could benefit from high interest with minimal need for alternatives (even when factoring higher inflation rates), whether it be bond or equity investing or otherwise.

In the months and years that have followed since then, however, the picture has been significantly - and more often than not tumultuously - different.

From the high of 15%, the base rate steadily fell to 8% by October 1992. From thereon, this decline continued, with rates of 6.75% (in October 1995) and 4.50% (in October 2005). Post credit crunch, we have seen long-standing rates under 1%. The rate fell to 0.5% in April 2009, dipping to 0.25% between August 2016 and October 2017- before its current position ‘back’ at 0.5%.

Inflation rates (CPI) since 1989 have ranged from 7.61% (in 1990) to 0.75% (in 2000), with a rate of 2.94% in 2017 (historic). This rate of inflation might appear favorable to policy makers and from traditional macroeconomic viewpoints. For investors, however, this current rate- along with the low interest rates- spells trouble.

The effect of inflation on cash savings

The result of extremely low interest rates and overriding inflation effectively erodes the value of any cash holdings. Put simply, after tax, the rate of interest you earn on your savings must be greater than the rate of inflation, in order for your money to actually be growing.

A quick look at MoneySupermarket.com confirms that regular, easy access saving accounts yield little more than 1% on average today. Cash ISAs fare no better, with the majority currently returning below 1%. It is clear that holding significant amounts of cash as a saving mechanism is no longer a desirable option.

It is the key, in light of these trends, that consumers become aware of other options for their savings. Alongside this, however, it’s not just a case of awareness but also enabling consumers to access alternatives without fear, confusion or misunderstanding.

As financial markets become more complex and innovative, it can sometimes become tricky to see the light through the woods. Information is lost or simply too overwhelming, creating barriers where there should be none.

Simplified, easy and accessible investment options - backed by big data and sophisticated investment techniques - give power back to savings potentials and allow individuals to save for the things that matter most.

What are the alternatives?

In light of the above, we need to keep looking for viable and efficient alternatives. In a world of cryptocurrencies, an inaccessible property ladder for most first time buyers and artificial intelligence, it can sometimes feel daunting to look for alternatives. The truth is, however, that alternatives to cash savings exist and don’t need to be complex.

As well as cash ISAs, UK residents can make use of tax free investment ISAs of up to £20,000 per annum. Investment ISAs can include shares in companies, unit trusts and investment funds, corporate bonds and government bonds.

Low interest rates and the personal savings allowance (which allows basic rate taxpayers to receive £1,000 of cash interest tax-free each year) have led to investment ISAs overtaking those in cash ISAs. As of September 2017, the difference stood at £315 billion compared to £270 billion. Furthermore, investment ISAs are continuing to see impressive growth returns:

According to Moneyfacts.co.uk, March 2017 "Our latest research shows that the average investment ISA fund has grown by an impressive 15.8% during the 2016/17 tax year so far, the highest return seen since 2009/10, when the average return clocked in at 34.5%. By contrast, the average interest rate on cash ISAs (both fixed and variable rate) stands at just 1.01% over the same period, and even the top long-term ISA currently available will only pay 1.75%”

While it might be tempting to forego other investment or savings options on account of trends such as these, diversification and a long-term view point remain key, allowing investments to weather the ups and downs of the financial markets while delivering overall, healthy returns.

Ben Hollingdale is head of sales at Smarterly.

This article was provided by Smarterly.