The only welcome ‘rise’ in recent times is that savers are now being paid for holding cash deposits. Interest rates had been below 1% since March 2009 but inflationary pressures have seen the Bank of England base rate increase 14 times in succession, rising from 0.10% in March 2020 to 5.25% in August 2023. And while borrowers may be seeing higher outlays, it is good news for savers.
You can comfortably now receive ‘high 4%’ from smaller Building Societies and Challenger Banks on instant access accounts and 6% on a fixed 1-year Bond. Is there an argument for holding more in cash?
Short-term cash – maximizing your return
We always recommend holding cash to meet shorter-term needs and as an emergency reserve, so we fully expect you will have some cash deposits sitting around.
The natural inertia of the human condition means that depositors often do nothing and the cash holdings sit earning little or no interest. The availability of a 6% 1-year Bond doesn’t mean you are actually deposited in it! There is an estimated £250bn held in UK savings accounts earning little or no interest. Whilst this has fallen as higher rates are pulling in new money and more people are switching, it does require an investment of time and effort.
If you currently have large balances sitting in your current account or a mainstream bank savings account, then it does now start to be worth investing an hour or so one evening to see what more you get. If you are moving to lesser-known banks, then remember that only the first £85,000 is covered by the Depositor’s Protection Scheme so, in theory at least, the balance is not ‘risk-free’ cash if the bank goes under.
Also, consider the after-tax position. Unlike many savings vehicles (ISA, Pension and alike), cash holdings are taxed at your highest marginal rate (less an allowance if you are entitled to it). For a higher or additional rate taxpayer, this means that an instant access account paying 4.5% gross nets down to an effective rate of between 2.47% and 2.7%.
Longer term perspective
Higher cash rates are reflecting higher inflation as the Bank of England raises rates to dampen the economy with the aim of driving inflation out of the system. Once inflation becomes embedded it quickly erodes the long-term value of wealth. Older clients will recall the pernicious effect on the wealth of the high inflation of the 1970’s.
The Consumer Prices Index (CPI) currently sits at 6.4% having fallen from 7.3% in June. On this basis cash deposits, irrespective of the higher rates are losing value in real terms. Whether or not you are seeking to actively grow your invested wealth, virtually all clients have a goal to preserve the value of their wealth and that becomes more important and trickier in an inflationary environment.
Cash is an asset class that we actively consider alongside equities, bonds and some selected alternatives as part of our portfolios. The idea always being to diversify in order to reduce the risk and optimise the return without trying to second guess or time the market. We would hold cash when we can get a positive return and importantly, when the risk/return is better than other asset classes within the overall portfolio mix. Over the long term equity investing is the asset class proven to most likely preserve the value of your wealth. Depending where we are on the economic cycle and valuations of equity markets, we may therefore over or underweight the equity component in favour of bonds or cash but our core philosophy for long-term funds is to remain invested and to share in global economic growth.
Again it is also important to look at after-tax returns. With income tax rates higher than capital gains rates, there are advantages net of tax in getting relatively more of your return from capital growth compared to interest or income.
At present, there are opportunities to take this preference further by investing in UK gilts which have a nominal rate of interest set when they were issued way below the current interest rates. They can therefore be bought in the secondary market at levels below their face value and if held to maturity result in a capital rather than income return. Due to an anomaly in the rules, this capital return is tax-free and again is a very attractive option for funds with a time horizon of up to 5 years.
UK Plc also permits UK investors several tax-advantaged investment allowances that are not cumulative. As such they exist on a ‘use it or lose it’ basis. These include ISA, Venture Capital Trust (VCT), and General Investment Account (GIA) (using capital gains and dividend allowances). The use of these investments can for many be imperative in driving the financial plan and generating long-term sources of income and capital maximizing returns from the combination of tax and investment returns.
In summary, cash is an important asset class for short-term needs and sometimes, as part of a longer-term investment strategy. It’s good news for savers that rates are on the rise and there is some return to be had, but the reason for that is inflation – a long-term destroyer of wealth. If you are holding large sums of cash do hunt down some attractive rates and don’t leave cash sitting unloved at 0.10%. But always look at your cash levels in the context of your longer-term objectives.
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