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Why you’re probably saving too much cash

Saving cash has, historically, been a safe bet. If interest rates are level to or higher than inflation, the value of that cash saving will grow over time and the buying power will remain (at least) the same. What this means for a lot of people is that, when you hear the phrase “savings”, you immediately think of cash.

There are a few reasons that this can be a problem for savers. Firstly, and most importantly, interest rates are currently exceptionally low. The Bank of England set its base rate to 0.1% in response to the Covid-19 crisis and there are seemingly no plans to raise it any time soon. At the same time, inflation has been growing and recently topped 3%, way over the Bank of England’s target rate of 2%.

What this means is that, over time, the buying power of cash savings is declining. Let’s use an example to visualise the problem. Imagine you had £10,000 in 2010. At an interest rate of 1%, that £10,000 would have grown to £11,051 by 2020. Over that same period, inflation has averaged 2.8% per year, so you’d need to have £13,119 to have the same buying power. You can see the disparity in the chart above. When you consider that the base rate is currently 0.1%, the problem with holding cash over the long term becomes obvious.

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Growth can be found elsewhere

So, with cash no longer a safe haven, savers are looking elsewhere for vehicles to protect and grow their wealth over time. We believe that a fully diversified, actively managed investment portfolio is the best way to beat inflation and ensure that your buying power doesn’t take a hit over the long term.

If the growth of your savings is important to you, it is worth considering exactly what those savings are for in the short and medium-term. If you are unlikely to need access to the money in the short or medium term, growth can be more effectively found in stocks and shares portfolios. Exposure to the fluctuations of the stock market can be unsettling when it comes to your savings but, over a long enough timescale, the difference in growth can be staggering.

Looking at long term expected returns of assets like equities and bonds, we think that the probability of them delivering positive returns is, on the whole, pretty good. The problem is that this growth isn’t always straightforward. Individual assets can go up as well as down, particularly over a short time horizon, so the key here is to identify the right mix for your risk level and to avoid short term thinking.

So, perhaps you’ve built up significant cash savings and are worried about the effects of rising inflation. If you want to see what a long-term, actively managed, fully diversified investment portfolio could do for your savings, you can find out all the details here.

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As with all investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest.