There are no indications that negative interest rates are going to be imposed imminently. We don’t know which types of accounts or banks are at risk, but we know our clients are starting to worry about the prospect.
Negative interest rates would be the latest in a series of blows for savers, but you can protect your money from being eroded, without resorting to hiding it under the mattress.
How interest is paid
Our financial system has evolved to pay someone (called a saver) that holds their money with a financial intuition, like a bank. The pay the saver receives is in the form of interest on their cash. That encourages people to put money away for a rainy day, a specific purchase, or their future when they will no longer work.
Choosing to wait for your money to grow into a larger sum instead of spending today is prudent.
Banks lend the money you save with them to other people that can pay it back at a higher interest rate than you are receiving. These are individuals or businesses that want to spend today rather than save up for their big purchase. The difference between the interest rates being paid to the bank and paid by the bank to you, is kept by the bank as profits.
Now what’s hard to grasp, is the idea of this situation being reversed. As we have said, we are not yet at that stage. However, rates are very low for savers and at zero on a typical business account. That means, as inflation rises, the value of your money reduces.
Inflation is simply the measure we use to track how much prices have changed on a year ago. For example, if prices are increasing at 1% per year and you are receiving 0.5% interest. The rate at which the value of your cash is growing, is slower than prices are rising. Reducing what you could buy with your savings.
So although we don’t have real negative rates right now, your cash savings could be losing their spending power anyway.
What happens when the Bank of England lowers rates
As the Bank of England cuts rates, the income banks can achieve from their loans falls. This is most apparent on tracker mortgages because they are linked to the base rate. When the rate banks can charge for loans falls, it squashes banks’ profits and ability to save cash on their balance sheet to protect themselves from defaults.
The Bank of England has implemented low interest rates to encourage us to increase our spending today, pushing up demand for the things companies produce, prompting them to invest and not lay people off
Here’s an example of how negative interest rates are playing out in Sweden. A bank called, Riksbank, cut their base rate to -0.1%c in February 2015 and again to -0.5% in February this year.
Large Swedish companies are willing to pay negative rates while it sits in their bank accounts. The alternatives could charge them more and their initial cash sum could be at risk.
Small companies and individuals are receiving zero interest. They aren’t paying negative interest rates. The value of their savings is reducing against inflation as we explained, but at least the cash is safe.
Should we panic?
We live in extraordinary times, and we cannot rule out that it may happen if the Bank of England lowers its base rates to a negative number. There is no reason to think that it will affect consumers’ personal savings accounts, but the situation is clearly worrying for savers.
Having said that, even the Financial Conduct Authority says the big banks do not offer good value to savers.
Better savings rates do exist, even if you need to be able to get to your cash.
If you’re concerned you’re not getting the best rates available right now, you can use our cash account portfolio tool to find out by clicking here.
Stick to your plan
Now is not the time to tear up your long term financial plan. You should always have a clear idea of what you are working and saving towards and stick to it. But that may mean holding less cash and investing in different assets instead.
Don’t abandon the principles of sensible investing. The plan comes first, returns come second.
Start by looking at what you can afford to put away and how often. Be sure that this will help you to achieve your goals and fits with your tolerance to risk. Then make sure you can generate the best return possible in each of your saving or investment products. Make sure your investments are liquid, so that they are straightforward to cash in if you need to.
2016 has been a turbulent year for savings, so here’s our plan for every saver.
Your legacy savings accounts may pay no interest and or significantly lower than new accounts. Shopping around and then switching should improve your returns. As we have said previously, according to Financial Conduct Authority (FCA) 80% of people with easy access accounts haven’t switched over a 5 year period, yet this is often the best way to improve the returns on your cash.
Pay Down Debt
The cost of borrowing is almost certainly higher than the returns from your cash savings. Find out more from our recent article about average mortgage rates being at their lowest ever.
Consider Converting some Cash Savings to Growth Assets
Income from cash deposit has fallen whereas dividend income from popular equity income funds has remained steady. Combined with capital growth, holding equities could make a big contribution to your long term plans.
When you need help with planning your financial future, our professional team can develop a portfolio that’s right for you.
Use Your Full Tax Allowances
Use all of your tax entitlement, especially the new personal savings allowance. Couples can combine your allowances with some planning.
Use your ISA Allowances
An ISA shelters interest from the taxman and that can contribute to your overall returns. Using your ISA allowance is good tax saving discipline even with the new personal savings allowance.
The value of investments can go down as well as up and you may not get back the amount invested.