Why Savings Still Matter

Savings AdviceThis article was originally produced by Martin Bamford (Managing Director of Informed Choice Ltd) on 9th September 2011 at www.icl.ifa.co.uk.

The outlook for interest rates in the UK remains incredibly low. By the time the Bank of England announce their interest rate decision each month, most economists and commentators have already decided that rates will remain on hold. Now that the economy appears to be slowing even further, the speculation is less about when interest rates will go up but whether they might go even lower.

Those of us with mortgages are probably rejoicing this prolonged period of very low interest rates. It should, in theory, be lowering the monthly cost of mortgages and making more money available to spend and therefore boost economic prospects. Your country needs you to spend the money you were previously allocating to mortgage payments on consumer electronics and other goods from the High Street.

In reality, it doesn’t appear to be working out quite like that. Interest rates on mortgage products might have fallen, although often not by as much as the Bank Rate has dropped. The popularity of fixed rate deals means that many with mortgages have not benefited from falling interest rates.

Even when mortgage payments have fallen, it does not necessarily mean borrowers are out spending their spare cash each month. Uncertainty in the job market is one reason why some people are cautious about spending their cash. Stubbornly high price inflation has pushed up the cost of other goods and services we all consume, so any savings on mortgage payments are being offset to some extent by higher fuel and food prices.

The flip side of lower interest rates is the impact these have on savers. Some groups have been vocal since interest rates fell, about the consequences of lower interest rates for elderly people. Those in retirement often use the interest on cash savings to supplement their other income in later life. Seeing your interest income fall so dramatically, whilst price inflation is high, can quickly have a dramatic impact on your household budget.

Recent figures from the Bank of England suggest that savers have missed out on more than £43bn of interest payments over the past two and a half years, when interest rates were first cut. The same figures show that borrowers have benefited by around £51bn, so the £8bn gap should in theory be the benefit to the economy.

Despite such low interest rates, saving remains the foundation of every sensible financial plan. It can be hard to find the motivation to allocate your money to cash savings when the reward for doing so is close to derisory. Yet cash remains the best home for your assets in a variety of circumstances.

What we have seen during the summer, which has coincided with historically low interest rates, is an extremely volatile set of investment markets. As a result, many savers are unprepared to expose their money to the stock markets or other investment markets in order to get the prospect for better returns.

Leaving money in cash in the current low interest rate, high inflation environment is a sure fire way to see the ‘real’ capital value (that is, the purchasing power of the money) eroded over time. Even a couple of years of this happening can have a dramatic impact on the real value of cash savings.

Cash does however offer a stable home for your money. The capital value will not fall in absolute terms, which is vital when you have a relatively short term financial objective. If you are uncomfortable with the possibility of the stock markets going down as well as up, cash is the only sensible option.

Having cash savings provides a valuable safety net, often referred to as an emergency fund, should things go wrong financially. With the UK economy still in uncertain territory, knowing that you can afford to pay the bills for three to six months in the event that you lose your job is really positive.

Now might be a unique opportunity to build an emergency fund of cash savings relatively quickly. It isn’t as gratifying as spending your surplus cash on the High Street, particularly with interest rates so low, but it can make a big contribution towards financial security and peace of mind.

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Picture courtesy of Martin Bamford via Flickr.com

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