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Why cash saving account interest rates are not as attractive as they seem

Celeste Garib, 21 August 2023

In their 2023 cash savings market review, the Financial Conduct Authority (FCA) found that UK consumers collectively held £1.5 trillion in savings accounts.

The review also found that, between January 2022 and May 2023, savers took £52 billion from easy access savings accounts, and moved £38 billion into fixed-term savings accounts.

This could suggest that more people plan to hold their wealth in cash savings and lock in over a longer period as interest rates are rising.

Indeed, the Bank of England (BoE) base rate rose again for the 14th time in August to 5.25% and savings account interest rates have been increasing alongside it.

According to the FCA, the average easy access savings account interest rate rose from 0.7% to 1.25% between January 2022 and May 2023. The average fixed-term savings account interest rate rose from 0.3% to 2.47% in the same period.

This may lead you to believe that taking money out of investments and putting it into cash savings is an effective way to achieve growth. You may also prefer cash savings because you receive guaranteed returns without having to assume the same risk that you do when investing.

However, holding more of your wealth in cash savings may not be the most sensible option as investments could offer potentially higher returns over time.

Read on to learn more about why interest rates are rising, and whether cash savings are really as attractive as they seem.

Why are interest rates rising?

The rate of inflation was 6.8% in the 12 months to July according to the Office for National Statistics (ONS). This level of inflation far surpasses the BoE target of 2% a year, which is why the Bank has been putting measures in place to bring inflation down.

Increasing interest rates is one of those measures, and it is the primary reason that the base rate has been consistently rising.

By increasing the base rate, the BoE hopes to make borrowing more expensive, and saving more attractive. This may then encourage people to hold on to their cash instead of spending it, which could slow down price rises and help to control inflation.

What does this mean for your cash savings?

Typically, higher interest rates are good news for savers, but it is not necessarily that simple. Before you move wealth from investments into cash savings, it is important to consider the full picture.

While you may see greater growth on your savings, remember those higher interest rates are largely a result of high inflation.

And when inflation is greater than the interest on your savings account – which is probable, as the best easy access savings account interest rate available on 7 August 2023 was 4.63%, according to MoneyFacts – your cash savings may lose value in real terms.

We explored inflation in a recent article and explained how it could affect your cash savings. Understanding this can help you see why high interest rates don’t necessarily mean that your savings will grow in real terms.

Additionally, when considered over a wider period of time, current interest rates on cash savings are not as high as they appear.

The base rate last reached 5.25% in February 2008, and it has been much higher than that in the past. For example, it reached its highest level of 17% in November 1979 and regularly exceeded 10% throughout the 1980s.

It dropped steadily during the 1990s but still remained higher than it is today in most years, until there was a sharp decline in 2008.

So, cash savings may not be as attractive as they appear. Especially when you consider how the persistent effects of inflation could dampen any growth.

Can investments beat cash savings?

While cash savings may be a safer option, and they are useful for short term capital expenditure and emergency funds, you can see that interest rates are still falling behind inflation. As such, they may not be an effective choice for long-term growth.

Conversely, investments offer more potential for growth that could beat inflation, however, this is of course not guaranteed.

According to data from Santander, if you put £10,000 in a cash savings account in the 15 years to December 2020 it would be worth £12,293.

However, the same £10,000 invested in UK shares over the same period would be worth £22,069.

The following graph demonstrates the difference in growth between cash savings and several different types of investments in the 15 years to December 2020:

Source: Santander

As you can see, while past performance does not guarantee future returns, the historical data suggests that investments may grow faster than cash savings and could beat inflation over an extended period.

Consequently, taking money out of investments to put into cash savings instead may not be a sensible idea. In fact, it could be more beneficial to do the opposite and invest more of your wealth.

Removing the barriers to investing

Unfortunately, while investing can be an effective way to protect your wealth during a period of high inflation, there are certain barriers that may stop you from investing.

The Financial Conduct Authority (FCA) ‘Financial Lives’ survey, published in July 2023, highlighted some clear reasons why you may be hesitant about investing and prefer to hold wealth in cash savings instead.

Often, it is due to a misunderstanding of the relative benefits of cash savings and investments. For example, 16% of people believed that Cash ISAs and Stocks & Shares ISAs performed roughly the same over the last 10 years.

However, as we have seen, stocks & shares tend to generate more growth than cash savings when viewed over longer time frames.

The survey also found:

  • 33% did not know that inflation can erode the real-term value of cash savings over time
  • 31% said they didn’t know enough about investments
  • 46% of people did not think that they had enough money to start investing.

These findings suggest that the main barriers to investing are a lack of confidence or a lack of understanding about the relative benefits of investments over cash savings.

Fortunately, working with a financial adviser can help you fill those gaps in your knowledge, so you can invest with confidence.

Get in touch

If you need guidance on your cash savings and investments, we are here to help.

Email hello@fcadvice.co.uk or call 0333 241 9900.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investments (and any income from them) 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. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.


Categories: Investment

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