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Why it may be unwise to hold too much of your wealth in a savings account

In recent months, headlines have described in detail that rates on savings accounts have been rising significantly. 

Indeed, Moneyfacts reveals that the best easy access savings account offers a rate of 5.22% as of 15 November 2023. For reference, the Guardian shows that the average rate on an easy access savings account on 14 November 2022 was 1.16%, a rise from 0.19% during the same period in 2021. 

This considerable rise can be attributed to the Bank of England (BoE) base rate, which it raises in an attempt to combat inflation. This rate stands at 5.25% as of November 2023. 

Even though rates on savings have risen significantly recently, it could still be unwise to hold too much of your wealth in a typical account. 

Continue reading to discover why this is the case, and some alternative homes for your wealth that you may want to consider. 

Inflation could erode the purchasing power of your wealth in a savings account 

Even though rates offered by savings accounts are currently much higher than they have been in the past few years, it’s important to remember that they could still be lower than the rate of inflation. 

The Office for National Statistics reveals that the Consumer Prices Index (CPI) increased by 4.6% in the 12 months leading to October 2023. According to this rate, £1,000 worth of goods and services one year ago would cost you £1,046 today.

Meanwhile, as noted above, the best rate offered by an easy access savings account is 5.22%, meaning that if you saved £1,000 a year ago, it would be worth £1,052.20 today. 

While, in this instance, your savings would manage to outpace inflation, it’s important to remember that the CPI does tend to fluctuate, and the rates offered by savings accounts are often lower than inflation.

For example, the CPI reached heights of 11.1% in October 2022, while savings rates hovered around 1%. 

Moreover, if inflation continues to drop, the BoE could reduce the base rate in response. This may mean that savings accounts follow suit, and the rate you receive on your savings could eventually fall back down below the CPI. 

In this scenario, the purchasing power of your wealth would essentially be eroded in real terms since the rate of inflation would be higher than the interest you receive on your savings.

Research from Unbiased goes further to show just how much inflation could affect your savings. If you held £10,000 of your wealth as cash, and inflation rose by just 2.5% each year, the purchasing power of this sum of money would decline to £7,812 in 10 years, or even further to £5,394 in 25 years. 

You could miss out on invaluable protection if you hold too much of your wealth in one place

It’s also important to note that, if you hold too much wealth with a single savings account provider, you could lose your guarantee of protection should that institution fail. 

This is because the Financial Services Compensation Scheme (FSCS) protects up to £85,000 of your money should the organisation that is looking after it fails. This includes:

  • Banks and building societies
  • Credit unions
  • Debt management companies
  • Life and pension providers
  • Investment companies. 

So, if you hold too much of your wealth as cash in a savings account, anything above the £85,000 FSCS guarantee could be lost should the worst happen and your bank fails. 

There are some alternative homes for your wealth worth considering

So, now that you understand some of the downsides of holding too much of your wealth in a savings account, you’re likely wondering where you should hold your cash instead. Read on to discover some potential alternatives. 

Invest it instead

Rather than saving your wealth, you could invest it, as this could help it keep pace with inflation. For instance, you could invest your money through a Stocks and Shares ISA, allowing you to invest while protecting your money from Income Tax and Capital Gains Tax. 

To show just how much investing could help your wealth keep pace, or even outperform, inflation, Barclays examined what £10,000 would be worth if you held it in cash, versus investments, between March 2018 and February 2023. 

The data shows that £10,000 held as cash savings over this five-year period would eventually be worth £10,068. Meanwhile, if you invested the money instead, it would have been worth £12,754 by the end of the five years. 

For reference, the BoE inflation calculator reveals that £10,000 in March 2018 would be worth £12,074 in February 2023, highlighting that investing over the above five-year period would have helped your wealth outpace inflation.

It’s important to remember that investing should ideally be a long-term venture. As such, if you think you’ll need to access your cash in the meantime, it may be worth considering another home for your wealth. 

Or, you could hold a certain portion of your cash depending on your short- and medium-term goals and aspirations, then invest the rest that you may need to support your long-term goals. 

Save for your future in a pension

If you’ve been thinking about your future security, then it may be worth saving more of your wealth in your pension.

Perhaps the best thing about doing so is that any contributions you make are tax-efficient since you receive relief at the basic rate of tax up to the Annual Allowance. This stands at £60,000 as of the 2023/24 tax year, or 100% of your earnings, whichever is lowest. 

Essentially, this means that a £100 contribution would only “cost” £80, with the additional £20 provided by the government. 

If you’re a higher- or additional-rate taxpayer, you can claim an additional 20% or 25%, respectively, through a self-assessment tax return. This means that if you are an additional-rate taxpayer, a £100 contribution would only “cost” you £55 once you’ve claimed the extra tax relief. 

Bear in mind that your Annual Allowance may be lower if you are a high earner or have already flexibly accessed your pension.

What’s more, any wealth held in your pension is typically invested, allowing it to grow and giving it the opportunity to outpace inflation. The pension provider, Penfold, reveals that, over the last 40 years, pensions have seen an average return of 7%, which is above the current rate of CPI. 

Also, by saving some of your wealth in your pension, you’re ensuring you have more funds available for later life. This could bolster your confidence that you can support your dream lifestyle during the next phase of your life. 

Get in touch

If you’re still unsure where the best home for your wealth would be, then we can help. 

Please email enquiries@mkcwealth.co.uk or call 020 8946 8185 to get in touch.

Please note

The value of your investment 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.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

7 December 2023