https://www.moneyfarm.com/uk/glossary/cash-isa/Ten years after the beginning of the financial crisis, savers are having a tough time at the centre of the perfect inflation storm.
The return on cash savings accounts are negligible and inflation is continuing to run ahead of the Bank of England’s target, which means the savings you’ve spent years building up are silently losing value.
A decade ago, the cracks that would lead to the largest financial crisis of a generation appeared globally. As financial markets collapsed, many investors would have got their fingers burnt as savers let out a temporary sigh of relief.
Central banks subsequently rolled out unprecedented monetary policy, which involved slashing interest rates and launching quantitative easing programmes – where new money is created to buy investments like government bonds.
But this is where things started to get tricky for savers; rock bottom interest rates fell through into the returns offered on savings accounts like cash ISAs.
Fast forward to 2016 and Bank of England governor Mark Carney decided to cut interest rates again to an all-time low of 0.25% to prevent Brexit uncertainty bringing the UK economy to a standstill.
Savings that once earned a decent return sitting in a cash account – an average of 5.5% in 2007* – have now sat idly for over 100 months. The Bank of England’s November interest rate rise to 0.5% won’t alleviate much of this pain.
When financial markets and economies crash, it might seem sensible to keep your money in cash. After all, the £10,000 you’ve spent years building up in your savings account will still say £10,000 in a year’s time – plus any interest earned from your account.
Unfortunately, this number doesn’t reflect the impact of inflation. Can you still buy the same amount with your savings? After all, that is why you save, to spend in the future.
How does inflation impact my savings?
Brexit has made it even harder for Brits over the short-term. Whilst the best returns on savings accounts reach just over 1%, the pound’s devaluation following the referendum has accelerated inflation.
Inflation measures the rate of price growth for general goods and services by monitoring the value of an extensive shopping basket of items. It can have a detrimental impact on the value of your money and eat into the purchasing power of your savings.
Inflation stayed steady at 2.6% in July, which essentially means the price of goods and services grew by 260 basis points. If your money isn’t earning a return that matches the rate of inflation, it’s losing purchasing power.
What does this mean for your savings? Imagine you had £10,000 sat in your cash ISA in 2007, after four years of saving up your cash ISA allowance.
If you’d kept it in your cash ISA, earning an average of 2.2% a year, your £10,000 would still just be worth under £9,600 today – you’ve effectively lost £400 in purchasing power.
How can I offset the impact of inflation?
One way to stop inflation eating into the purchasing power of your money in this current environment is to invest it. A diversified investment portfolio and some patience can get you one step closer to achieving your financial goals.
Investing is about balancing risk and return to protect your money for your future. What you invest in depends on your investor profile – what you’re saving for, when you’ll want your money, and your personality.
Whilst no investment is risk-free, some investments, like bonds, are deemed ‘safer’ than others, like equities. The higher the return you want, the more risk you take – although this means you also have further to fall.
If you knew you had wanted to save for ten years and had a steely set of nerves – essential to ride the markets during the financial crisis – you may have invested your £10,000 in a portfolio split 60% equities and 40% bonds.
You’d be laughing if you had, your £10,000 would has risen 25% to £12,550. Of course, it helps that equity investors have enjoyed the fruits of a post-financial crisis bull market.
But this just highlights how a long-term investment strategy can be a good springboard to help savers take on the right amount of risk for their family.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
