Retaining an appropriate level of deposit based funds is a key ingredient to any robust personal financial plan, whether you are working or retired. The level of cash to provide the required level of comfort can vary significantly depending on your circumstances and preferences. We would usually suggest 3-6 months of regular expenditure be held as a cash reserve, but this figure needs to be sufficient to cover any planned expenditure plus unplanned or emergency expenditure. For some, it may be £10,000, for others £50,000 or more. This will then provide a sense of comfort without the need to disturb longer term investments.
A reason for the distinction made between cash reserves and longer term invested funds is the assumption that cash will not keep pace with inflation, whereas one would usually expect longer term invested monies to at least keep pace with inflation whilst also of course introducing some risk to capital invested. Monies retained in a deposit environment will usually fall in value in respect of its buying power, so the compromise is accepting this “loss”, to ensure immediate access to funds. Getting this balance right; between funds held in savings and funds invested is important so that we do not inadvertently have too high a proportion of our wealth falling in value in real terms.
Let's consider the rate of inflation for the 10 years to 2019, (source: CPI Bank of England (BOE) inflation calculator). To have the same buying power in 2019, £1,000 held, would need to have grown to £1,351 or 3.1% pa from 2009. The average return of a balanced managed investment fund over the time period was 6.3% pa (Source: Trustnet – AFI balanced sector 2009-2019). The BOE inflation target is currently 2% pa but in the last 12 months the rate has been well below this level. The BOE base rate is now only 0.1% and we have seen savings rates plummet within the last year to such a level that a recent article in the Daily Mail referenced that saving via cash ISA’s in the UK’s biggest banks would have paid savers as little as £38p on a £1,000 balance.
The higher the interest rate earned, the lower the level of inflationary “loss” and for the last couple of years it has though been possible to get a close to market leading rate with 100% Financial Services Compensation Scheme (FSCS) protection through National Savings & Investment (NS&I) including for example income Bonds which, until November 2020, paid 1.16%pa. This relatively “high” rate saw a huge influx of funds into NS&I, especially from March 2020 when the Bank of England base rate dropped to 0.1% and world stock markets fell significantly . In September alone £5bn of retail funds flowed in.
However this NS&I rates were slashed on 24th November 2020, the same income Bonds are now earning just 0.01%. Research by AJ Bell in December 2020 showed that of 500 NS&I customers approached, 31.7% were unaware of the rate cut with many savers unaware of the personal impact to them of this change. On a balance of £100,000 the previous rate would have provided a gross interest return of £1,160 pa compared to the new return of £10 pa so the impact is substantial.
It is clearly now more difficult than ever to generate any sort of meaningful return from deposit based savings. This does not though mean we should not hold funds in savings indeed it is important that we do, however, we should be clear about the compromise being undertaken – a guaranteed loss of buying power to retain access to and control of funds versus holding the right proportion of our wealth in savings. Placing funds on deposit is not a substitute for investing and what can be critical to ensuring personal goals are met is selecting the right balance between saving and investing.
There has even been speculation recently that there could be a further BOE base rate cut and the potential for negative interest rates. Recent research published by Aegon suggests that if this were to occur 42% of those surveyed would use it as an impetus to invest. Investing can include of course, making contributions to pensions which provide the immediate benefit of tax relief. The net cost, for example, to a basic rate tax payer of making a £10,000 pension contribution is £8,000 and for a Higher Rate Taxpayer the net cost would be only £6,000. Therefore, whether interest rates simply remain very low or could go negative, there are clear factors in play which appear to encourage savers to consider committing further funds to investments.
One key factor of course which can put people off investing rather than saving is the potential of loss of capital, especially in the face of significant world events e.g. the 2009 Banking Crisis and the Covid-19 Pandemic. The short term effects of the current pandemic on investment markets was indeed significant. Using the same AFI balanced sector referenced earlier, and over the last 12 months, returns fell by around 20% to the middle of March 2020 but have since recovered strongly, such that the full 12 month period has shown a positive return of 7.1%. (6.3% pa average over the last 10 years). Clearly before any decision to invest is taken, full consideration of attitude to risk, capacity for, and tolerance to loss, needs to be undertaken, as does investment experience, objectives and timeframe.
At Armstrong Watson we work with you to construct a robust plan with a sound financial base to cover emergencies and help plan for the future. With our ongoing review service we will regularly review these plans so they remain on track.