Life as a cash saver is great now interest rates are higher right? Wrong, for a lot of people. While the very best rates available on the market are comfortably beating the rate of inflation, a lot of cash is still languishing in accounts paying miggins in interest, if that.
Bank of England data shows that £253 billion is sitting in bank and building society accounts paying precisely zero interest. This is money which is simply wasting away once the effect of inflation is considered. It would hold as much value stuffed into a mattress, if you could find one that would hold a quarter of a trillion quid.
ON THE RISE SINCE THE FINANCIAL CRISIS
The amount of money held in accounts paying no interest has been on the rise since the financial crisis, as a result of low interest rates and bank funding schemes introduced by the Bank of England. Between March 2009, when interest rates were cut to the emergency level of 0.5%, and October 2022, this inert cash pile rose from £58 billion to a peak of £272 billion, according to Bank of England data.
Given the dramatic rise in interest rates over the last few years, you might have expected this cash mountain to crumble away. But while it has been trimmed back to ‘only’ £253 billion, there hasn’t been a wholesale sea change. The last time interest rates were at 5.25% as they are now, in April 2008, there was £33 billion held by households in accounts paying no interest. Even accounting for the increased stock of household savings over that period, that still looks like a phenomenal explosion in this type of account and suggests banks and building societies are making hay with large swathes of savers’ cash.
Even cash held in instant access accounts that do pay interest isn’t providing savers a whole hill of beans in interest. The average rate on cash held in instant access accounts is currently 2.1%, again according to the Bank of England. That’s below the rate of inflation and compares very unfavourably to top savings accounts on the market, which are paying in excess of 5% per annum.
Tips to avoid a low interest rate trap
Savers can simply wait for banks and building societies to improve rates on these accounts, but on current form, which looks like it’s going to be a glacial process. For those who want to act themselves to avoid falling into a low interest rate trap, here are five pointers.
Keep as little as possible in current accounts. These accounts are transactional and consequently tend to pay very low levels of interest. Make sure you do leave enough in there to cover bills and outgoings though, to stop you dipping into your overdraft and paying interest and fees.
Shop around for the best rate. Trusting your high street bank or existing provider to give you the best deal on savings won’t get you very far. Use comparison sites or cash savings hubs to find and compare the best rates available on the market.
Don’t forget Cash ISAs. You may not be able to get quite as much in interest from an ISA as the very top savings accounts, but after tax, the protection afforded by the ISA could mean you end up better off. It depends what rate of taxpayer you are and how much interest you have from other sources. That’s because the Personal Savings Allowance allows you to receive a certain level of interest tax-free every year. For basic rate taxpayers this amount is £1,000, for higher rate taxpayers it’s £500, and for additional rate taxpayers it’s £0. Interest received annually above these levels is taxable and would therefore benefit from being held in a Cash ISA.
Consider gilts. DIY investors have been ploughing large sums into short-dated, low coupon gilts recently. These come with a government guarantee of repayment on maturity and much more attractive rates of return now interest rates have risen. The particular appeal though is that capital gains from gilts are tax-free, so if you can identify bonds where almost all the return is coming from capital appreciation rather than an income yield, you pay less income tax. This approach is only for those who understand gilts and are willing to roll up their sleeves to find appropriate bonds.
Think about investing. Conventional financial advice is you should have three to six months of expenditure in cash, so if you’ve already got this parked in cash accounts, you should think about investing any excess for the longer term. Data from Barclays shows that over 10 years there is a 91% chance shares will outperform cash.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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