Returns on Cash ISAs are creeping higher, but not enough to offset inflation. Savvy savers should consider other options to protect their money and make it work harder for the future.
In the last couple of weeks two small but important numbers were released. The Office of National Statistics announced that over the year to 31 January, prices went up by 4 per cent (as measured by the Retail Price Index). We last had inflation at this level in 2012 – it has steadily crept up from around 1 per cent since Autumn 2016.
If we can’t increase our income then the fact that the pound in our pocket has less buying power is a problem
The fact that things are getting more expensive is not really a surprise. Provided our earned income keeps up with it we don’t really feel discomfort. However, if we can’t increase our income then the fact that the pound in our pocket has less buying power is a problem. The more reliant you are on your capital to support your lifestyle, the more painful this becomes.
Another small, but important number was released by The Money Charity in February. Cash ISA interest rates are, on average, at their highest level since May 2014. In fact the change since the previous month was the single biggest jump in the space of a month since records began. This sounds like great news… until you look at the detail.
Average Cash ISA interest rates were 0.91 per cent per year in January 2018 (and ‘records began’ in 2011). After trawling the internet, the best rate we could find over one year (fixed rate) was just 1.45 per cent (moneyfacts.co.uk). These rates are significantly lower than inflation.
Cash ISAs may be a useful way of managing short term savings (money you need within 5 years) in a tax-efficient way.
But over the longer term cash ISAs simply can’t maintain your buying power. This is because they don’t provide high enough returns to beat inflation. And this means that you will be drawing more and more heavily on your capital to keep up with the costs of life:
|Where do you store your cash?||Interest rate||Value after one year||Buying power after one year||Buying power after 10 years|
|Under the mattress||–||£20,000||£19,200||£13,297|
|Average cash ISA||0.91%||£20,182||£19,382||£14,612|
|1-year fixed rate cash ISA||1.45%||£20,290||£19,490||£15,447|
These figures assume the current UK rate of retail price inflation remains at 4% per year.
And it seems that the penny has dropped. The amount invested in Cash ISAs dropped by a third last year, with almost £20bn less being saved in the year to April than the previous 12-month period.
So what can you do about this?
Here are two ideas:
- Work out how much money you need to hold for shorter term savings. Money that has a longer-term purpose should be invested for capital growth to help counter the effects of inflation. Unlike cash, the value can then go down as well as up, but over the longer term we would expect its value to increase.
- Consider alternative approaches, such as an Innovative Finance ISA (IFISA). Crowd bonds offered by the likes of Downing can be held within an IFISA and offer the potential for significantly higher returns than Cash ISAs (typically between 4-7 per cent a year over 5+ years).
This second option comes with some important caveats. Diversifying your ISA portfolios and investing in assets uncorrelated to the stock market should always be part of a broader plan. You should not take all your savings and plough them into alternative finance! Crowd Bonds and peer-to-peer lending put your capital at risk, and do not offer deposit protection through the Financial Services Compensation Scheme. In short, you could lose some or all of your money.
However, provided that you are both investing and saving then it is worth asking whether your ISA allowance could work harder and provide returns on your savings to beat inflation over the longer term.