- 20th Jan 2015
Can you afford to keep holding cash?
With inflation being pushed to a record low it appears the interest rate rise, which has been waiting on the horizon for some time now, will stay there a little longer. Good news for variable mortgage holders, and good news for borrowers in general. But what about the impact on your savings?
And why are interest rates being kept so low anyway?
A quick ‘jargon-free’ economics lesson
Interest is the cost of borrowing and the benefit of saving. Lowering interest rates encourages more borrowing, because it makes borrowing cheaper. But, there is less of an incentive to save because it becomes a less attractive option. For the economy, more borrowing equals more spending and thus more demand for goods and services. But higher demand also leads to an increase in prices.
So, essentially, inflation and interest rates have a theoretically inverse relationship. And, as the base interest rate is set by the Bank of England, it can be used as a tool to drive and control inflation.
Unfortunately, there are other influencing factors too, the real world economy isn’t quite so straightforward – there are more than two moving parts. The recent drop in inflation is heavily down to falling oil prices, for example. A variable outside of the Monetary Policy Committee’s power.
For the UK inflation to move back towards the 2% target rate, the economy needs to be stimulated. Rising interest rates, and thus increased saving, will not help.
CPI 12-month inflation rate for the last 10 years: December 2004 to December 2014
What does this mean for those holding cash?
Essentially it means the return on cash products is likely to remain low for a while longer. Most interest paid by product providers is linked to the base rate, so until the base rate rises their interest rates won’t rise either.
Cash ISAs and current accounts can often seem like a safe, hassle free, haven for your savings. The easy option, almost. And while inflation is also low you may think this isn’t so bad. However, there is still an opportunity cost to holding cash; the potential for higher growth elsewhere. And it is potential, nothing is guaranteed of course.
Investing doesn’t have to be complicated. Nor is excessive risk a requirement. A big worry for cash investors considering putting money into the stock market is risk and volatility. With holding cash there’s very little risk involved, whereas putting money into the stock market is deemed to be a riskier investment due to the volatile nature of it. But it is possible to have exposure to the stock market without having to subject yourself to stock market volatility that you can’t tolerate or withstand. The way to do this is to have a diversified portfolio that is tailored to you and your risk preferences.
A diverse portfolio allows you to spread risk across a number of asset classes. It can help avoid the ‘all your eggs in one basket’ trap and thus mitigate your portfolio’s volatility.
Of course, a lot of investing depends on your personal circumstances and your time in life – finding the right balance is the key. If you’re a year away from retirement then by all means a cash orientated portfolio may well be appropriate. But, if you’ve got 30 years until you need your savings and you can tolerate an element of risk, investing is quite possibly the way forward. Risk is reduced over a longer time period too so volatility becomes less of a concern, and so an investment – at a suitable risk level – could be the right option.
Both cash and stock market investment have always been options for savers but a reduction in the comparative power of cash savings is a real concern for many people now. Where once holding cash was a way to accumulate savings, it’s now not much more than a way to try and maintain the value of your savings. Those cash savers looking for real growth may need to consider the alternative.
Other content you might find interesting:
- What are your reasons not to invest?
- Is 2015 the year you finally sort your finances?
- Why successful investment strategies are boring
Any news and/or views expressed within this article are intended as general information only and should not be viewed as a form of personal recommendation. This article is not directed to, or intended for distribution or use in, any jurisdiction where such distribution would be prohibited. To the extent permitted by law, Wealth Horizon accepts no duty of care or liability for loss occasioned to any person acting or refraining from acting as a result of any material contained within this article. Where past performance is shown, this should not be taken as a guide to future returns. Investment in the stock market is not a suitable place for short term money. The value of investments and associated income may go down as well as up and you may not get back the full amount invested.