This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Interest rates on cash savings can feel more attractive when they are going up. Yet, in the background, your money may not be growing in real terms. In fact, it could be losing value.
This is because of inflation – i.e. the rising cost of goods and services in an economy over time. Below, our Burnley financial planners explain how inflation can erode the value of cash, what the situation is in 2023 and what you can do about it.
Why does inflation erode the value of cash?
When you get your bank statement, your bank will likely want to draw attention to your interest earned. This is intended to help you feel good about your provider and, hopefully, want to stay with them.
However, if the UK’s rate of inflation rises higher than your cash interest rate, you stand to lose money in real terms. This is because the “buying power” of each £1 you own is going down.
For instance, suppose inflation rises by 10% in a 12-month period. This means that it might cost you £1.10 to buy the same item which cost £1 a year ago.
This would not matter so much if your savings also grow by 10% in this time. After all, a £1 saving would turn into £1.10. So your money keeps pace with the rising cost of living.
Sadly, this is not generally how regular savings accounts work. Their rates tend to consistently fall behind inflation, even during times when interest rates are going up.
For example, in 2023 you might be able to find an easy-access account which offers 3.85%. A one-year fixed-term bond could offer 5.25%. However, UK inflation is currently 8.7%.
Granted, 8.6% inflation is lower than the 10.1% reported previously by the Bank of England, and officials hope that UK inflation will continue to fall later in the year. However, inflation measures still remain higher than even the best cash savings rates available to the public in 2023.
How do I protect my savings from inflation?
Savers face a difficult situation when it comes to inflation and their cash savings. You might think that waiting until inflation comes down might eventually protect the latter. However, when that does happen, lenders are likely to lower their rates.
The first step, naturally, is to shop around for the best rate(s) available to you. Do not feel obliged to remain with your bank, even if they have treated you well. If other providers can give you a better deal, consider switching your savings account(s) to them.
Some savers might want to consider Premium Bonds as an alternative to cash savings. These offer the chance of winning a “prize draw” each month, rather than a guaranteed interest payment. Premium Bonds are offered by NS&I, are covered by the Financial Services Compensations Scheme (FSCS) and claim their odds stand at 24,000 to 1.
The minimum you can pay in is £25, and the maximum is £50,000. The more Premium Bonds you own, the higher your chance of winning a tax-free prize draw. However, bear in mind that the odds of winning anything are still very low, even with a large investment.
Another option is to consider investing your money into other assets – outside of cash – which have a better chance of providing returns which match, or beat, inflation.
For instance, investing in shares can be a viable option. Since 1957, the US-based S&P 500 has delivered an average 11.88% return to investors up to 2021. Since the dollar averaged at 3.53% inflation over that timeframe, it follows that the S&P delivered an overall “real” return.
Investing in shares does involve risk. After all, you may invest in a stock or a fund which does not grow as you hope. Perhaps it even falls in price and you do not get your initial investment back. This is where working with a financial planner can help.
A professional can advise not only on how much of your wealth should be held in cash, versus other investments. They can also guide you on how to construct an investment portfolio which best reflects your goals, risk tolerance and time horizon.
Investors are not simply limited to shares. Another option might be to invest in bonds – or even inflation-linked bonds, which provide returns that adjust over time in line with an official inflation measure (e.g. the Consumer Price Index).
These can offer a lot of peace of mind to investors. However, speak with a financial planner about the risks beforehand. For instance, inflation-linked bonds have an inverse relationship with interest rates. So, if interest rates keep going up, this could result in capital losses if you sell your bond(s) before they reach maturity.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
