For years low-interest rates on savings accounts have, understandably, made many savers wonder whether they’d be better off stuffing their cash in a mattress. Now that rates look likely to increase, we look at how you can make your money work harder, without having to hoard it.
Keeping cash stashed under the bed - or more realistically in a safe - used to be an option for savers before bank accounts existed. Now, there is no safer place for your money than in a bank and building society account.
The Financial Services Compensation Scheme offers a guarantee of up to £85,000 per single account if your bank or building society goes bust.
There’s also the issue of inflation – keeping your cash somewhere that it’s not earning interest at the same rate as or above the rate of inflation, means that in the long run, it buys less and less.
It’s true that home contents insurance will cover you for some cash that’s been left in a house damaged by fire or flood, but the limits are not particularly high. The maximum tends to be about £500.
Inflation is around 5% at the moment and is expected to rise in 2022, which means that your savings may lose their value if they are not earning any interest.
If you had £100 stashed under your bed or in your home and inflation continues to be around 5%, in two years that £100 would only be worth £90.
The good news is if you have been holding on to cash, now could be a good time to save ir invest it.
Saving and investing are pretty similar concepts. Saving is a catch-all term that normally describes the action of being careful with cash; you can be said to be saving money by spending less on something for example.
Savings accounts are run by banks, building societies and credit unions. They pay savers interest in exchange for holding their cash.
The bank uses cash from savings accounts to lend to other people, to invest in a business or for other potentially profitable schemes.
The bank or building society is required to keep a proportion back, however, so that people can withdraw their savings when needed. This plan works rather well unless everyone tries to get all their money back at once. That’s when you get a “run on the bank” something the financial institution rarely survives. This was last seen in the UK with Northern Rock in 2007.
Investing, whether through a bank or other body, is a far more direct way of growing your money.
An investor is someone who wants to see a return on their money and will often be prepared to take a risk with their cash to do so. The risk may come from tying up their funds for longer or putting it into investments that might do well, but that might also fail. You could say investing is a more proactive version of saving.
Before you start a savings plan you should aim to have at least three months worth of emergency expenses in an easy access savings account. This would include rent/mortgage payments, council tax and essential bills along with money for food bills.
All savings accounts will pay some amount of interest. What you need to do is work out why you are saving, or what you are saving for. That will help decide what type of savings account you need. Some current accounts pay better rates of interest than some basic savings accounts, so check with your bank or building society first. Ask yourself:
Do you need to be able to easily access your cash? If so, then an instant access account might be best for you. These do tend to pay the lowest rates of interest of all savings accounts
Are you happy to tie your money up for years? If you can afford to put away your money or only need to make one or two withdrawals a year, you could get a better rate of interest. These are normally fixed interest or notice accounts
Are you saving for something in particular like a wedding or holiday? You may be better off putting your money in an account that offers an introductory interest rate, which maximises the rate of interest you get but you need to be prepared to move it when the rate drops back down
Do you want to save a small amount regularly? A cash ISA that allows you to save up to £20,000 a year tax-free is worth considering. Most Cash ISAs have no minimum deposit so you can start saving small amounts
ISA stands for individual savings account. A Cash ISA allows you to save up to £20,000 a year, and you don’t pay tax on the interest you make. If you exceed your annual personal savings allowance, you will have to pay tax.
An ISA is essentially a wrapper, which protects your savings from tax, you can choose to use your ISA allowance to invest in cash, or stocks and shares, or a combination of both.
An ISA might not always offer the best savings rate, so you will need to compare other savings accounts to see if the tax-free benefit is outweighed by accounts offering more interest
These are the most basic type of savings account and allow you to withdraw your money whenever you like. They don’t tend to have a minimum balance either and some come with cash cards. This is the type of account where you might be better off keeping emergency savings.
Some easy-access accounts include a limit on withdrawals and an introductory bonus interest rate that might be fixed for the first 12 months. You need to keep an eye on the interest you earn as it may be that you can earn more interest by switching accounts when the bonus period ends.
You can’t access your money easily if you save into a notice account. You’ll have to give the bank or building society notice, normally 30, 60 or 90 days to withdraw funds. But in return, you tend to get better rates than with easy-access accounts. Many of these accounts also have introductory bonus rates, so you should keep an eye on the account and be prepared to switch your savings when the rate ends.
Regular savings accounts require savers to put a regular amount each month – hence the name. They reward savers who can commit a regular amount. The interest may vary, as with all other accounts. Savers can be restricted from paying in large lump sums.
These offer the highest interest rate of all savings accounts. You have to lock your money away for the term of the bond, which can be up to five years, and yu may need to put a large lump sum in to start the account.
But the longer you lock your money away for, the higher the amount of interest paid. These accounts are not to be confused with government bonds or gilts, which are money market instruments used by governments to raise money.
The first rule of investing is - be prepared never to see your money again.
Investing is a long-term and risky way to save. However, the returns can be worth it. A Stocks and Shares ISA is a good place to start, you can use your ISA allowance to buy shares and start with small amounts.
Share dealing websites or apps will allow you to buy individual shares or you can choose collective share investments, known as funds. Some funds are listed on the stock market as an entity in themselves while others invest in shares.
Investing needs diligence and you will also need to research your proposed investment.
Investing can be expensive, you will need to pay an annual management charge and possibly fees every time you buy or sell shares.
Unlike savings accounts, you don’t earn interest. Investment growth comes from an increase in the share’s or fund's value or through the payments of dividends or both. Dividends are payments given to shareholders, usually by companies that are doing well. This is known as income investing while investing with the expectation of an increase in the value of the share or fund is known as growth investing.
Most investing is a combination of growth and income investing.
Pensions are a form of long-term investment as a pension fund will use your money to buy a combination of shares and cash, as well as other assets, such as property.
Pensions also benefit from much greater tax breaks than standard savings accounts.
Pensions contributions get income tax paid back on them and if you take out a pension through your employer they are required to add to what you contribute in most cases.
But you won’t be able to touch the money until you’re at least 55 and while there’s no income tax on the way in, the money you withdraw from a pension fund does get taxed.
There’s at least £37bn sitting in lost or dormant UK pensions and more than a third of Brits have at least one missing pension. On average that means one in three has lost track of a pension worth £23,000. You can find a lost pension by contacting your old employers to enquire what pension schemes they set up for you if any. The UK government has a free database, the Pension Tracing Service, that lists the details of companies and personal pension scheme providers.
If you have any substantial debts then it may be a good idea to use your hoarded cash to pay those off before thinking about starting saving.
Traditionally, the interest rates on debts are far higher than the interest rates offered on savings accounts. Because of this, using your spare cash to eradicate your debts first could be a highly profitable move.