Updated 03 December 2020
Recent studies show that cautious savers are putting away more in cash than ever before. But with record low interest rates, these sums are fast being eroded by inflation. So what better places might there be for your money? Article by Nick Green.
People in the UK are sitting on more cash savings than ever before, according to the latest research. Lower spending as the result of the coronavirus lockdown has led to a pile-up of £77 billion in savings accounts in just the first half of 2020, compared to £82 billion across the whole of 2016. These are the findings of Janus Henderson Investment Trusts, which further suggested that by hoarding this amount as low-interest cash, Brits are missing out on around £1,350 of growth per household.
Of course, Janus have products to sell, so claims like these should be treated with due caution. But other research confirms some key facts: average (mean) savings per adult have risen from £273 a month pre-lockdown to £495 a month, according to Creditfix.co.uk. Meanwhile figures from the Yorkshire Building Society show that 30% of people are now saving £200 or more a month compared to only 21% in 2019, and that one in four people are increasing their savings.
However, this stashing of cash couldn’t have happened at a worse time, in the view of James de Sausmarez, director of Janus Henderson. Average interest rates on cash accounts are now just 0.39%, while the very best regular savings accounts offer 2.75% at most. ‘In my view, interest rates are set to stay low for a very long time, so there is no light at the end of the tunnel for cash,’ says James. ‘Banks call this “muppet money” because they know savers are missing out on much better opportunities elsewhere.’
Is this true? We’ll take a look at some of the popular alternatives to cash savings, the potential rewards on offer, the risks involved in using them, and the precautions to take if you do.
Investing in equities (stocks & shares) is one of the most popular alternatives to cash. The advantage is that you can potentially gain more growth over time (and often in the short term too) than you can from cash savings. Especially when cash interest rates are low, as they are now, equities can have significant appeal.
The disadvantage is that equities can also fall in value, so you can lose money – sometimes even all of it. The Covid-19 crisis wiped a third off global stock market prices, so anyone who bought just before it will have lost a large chunk of their money, which may take years to recover to its original level. This is always a risk to bear in mind.
However, on average, stock markets consistently outperform most cash savings over longer periods (5+ years). It’s also possible to spread your risk by investing a range of different equities, or through a fund. This doesn’t eliminate the danger of loss, but can reduce it significantly. If you plan your strategy carefully and take advice, you can keep the risk within acceptable levels for you.
Aside from simply buying shares, here are some of the ways you can invest on the stock market.
An ISA is a tax-efficient savings accounts, free of tax on the interest or growth. A stocks & shares ISA is one that holds non-cash assets such as equities (but can include things like bonds and investment trusts too). If you’re going to be investing less than £20,000 a year, it makes sense to use a stocks & shares ISA for whatever investments you buy. Note that if you also save into a cash ISA it will reduce your £20,000 annual allowance, but with interest rates so low cash ISAs currently have very limited advantages.
By reinvesting the growth plus the tax savings, your investment can grow inside the ISA more quickly than it could outside it.
Another option for holding investments is stocks & shares Lifetime ISA. This works in a similar way to an ordinary stocks & shares ISA, but with one large advantage and one key disadvantage. If you are saving specifically for buying a first home, or for retirement (or both), then everything you pay into your Lifetime ISA will get a 25% boost from the government, up to a maximum £1,000 bonus per year. However, if you withdraw money before the age of 60 for any reason other than buying a first home, you pay a 25% penalty (which will wipe out your bonuses and then some).
Index funds and exchange-traded funds (ETFs) are a relatively easy way to start investing in the stock market. They remove the hassle of picking specific stocks, and can be a more secure vehicle compared to speculating on the open market. Both are types of mutual fund that invest your money in a range of securities (securities include equities but also bonds). The diversity of these broad market funds can protect you from sector-specific crashes, which is why they’re considered lower-risk. A wide range are available and some are much riskier than others, but by taking independent advice you can choose one that suits your level of risk tolerance.
Unit trusts are a collective investment set up under a trust deed. Using pooled money, a fund manager will invest in a portfolio of assets on your behalf. The trust aims to invest in well-performing assets, usually equities, bonds and property funds, and usually pays out any returns quarterly or bi-annually as either income or growth. As usual, returns are not guaranteed, and you can lose money.
Investment trusts are similar to unit trusts, but with some key differences. One is that investment trusts are able to borrow money to buy more shares, whereas unit trusts cannot. This gives them more potential for generating growth, but also exposes the investor to more risk. An investment trust is also not just valued according to the value of the assets it holds (its ‘net asset value’) but by the demand for its own shares on the stock market. This offers you the chance to magnify your gains, if the net asset value exceeds the investment trust’s own share price.
One for the more experienced investor, value investing is what helped to make Warren Buffet his fortune. The principle behind value investing is simple: buy stocks in promising companies that are currently undervalued, and sell them years later when the company has fulfilled its promise. So much for the theory – the hard part is identifying those companies and predicting their fortunes. To do this successfully you’ll probably need a good few years of investing experience behind you, and will probably be successful in business yourself. It takes patience and a lot of initial capital, so is really only one for the wealthier investor.
If equities look like too much of a bumpy ride for you, then you might prefer investing in government or corporate bonds. A bond is basically a loan to the country or corporation that issues the bonds. You lend them your money for a few year, and they pay you back with interest.
Therefore, bonds are typically used to generate a predictable return over a set period of time. Bonds are usually described as lower risk than equities, but the reality is a bit more complex. The bonds of stable governments (gilts) are generally the most secure, but bonds from emerging markets or upcoming corporations will be far riskier – but should offer higher returns. As ever, it’s about balancing the risks against the potential rewards.
You can include bonds in a stocks & shares ISA, and some low-risk or medium-risk bonds can serve as a stabiliser against more volatile equities.
A variation on the bond theme that has grown in recent years is peer-to-peer (P2P) lending. This too is about making loans and being repaid with interest, except this time the loans are not just to businesses but also to individuals, via a central lending platform hosted online.
P2P lending has surged in popularity due to the prospect of much high interest rates than a cash savings account. P2P platforms superficially resemble savings accounts in the way they are presented to consumers, but it’s important to remember that they are not. Though they are regulated by the FCA, they are not guaranteed by the Financial Services Compensation Scheme (FSCS) if the provider collapses, so you can lose your money this way. Predicted returns are also not guaranteed. Nevertheless, it is possible to earn steady returns from the big platforms, some of which have been active since 2005.
You can now invest in P2P lending in a more tax-efficient way using an innovative finance ISA (IFISA). This is similar to the stocks & shares ISA, but contains P2P loans instead of equities. All the risks and caveats of P2P lending still apply, and the higher the predicted interest, the higher the risk. The IFISA can be good to hold concurrently with a stocks & shares ISA, as though the risks are broadly similar, they will not necessarily be vulnerable to the same risks (this is the logic behind diversifying your investments).
A distant cousin of P2P lending, crowdfunding is where you directly invest your money in a new company or project. Equity or investment-based crowdfunding gives you a share in the business, and thus eventually a portion of the profits. If you’re lucky enough or shrewd enough to pick the next big thing – as the crowdfunders of online bank Monzo did – then it can be one of the fastest ways to grow your money. Far more likely is that you will simply earn a thank-you and perhaps some free gifts from the company. Crowdfunding is more in the area of speculation than investment, but there’s no doubt it works for some.
Oil and gold are investments that carry their own mystique. Despite their reputation, they aren’t typically a fast route to riches. As assets, oil and gold are effectively chalk and cheese, with oil being inherently volatile and gold being famously stable in a crisis.
Oil prices are highly sensitive to a wide range of factors, mainly supply and demand but also global politics. Oil stocks, futures or options can therefore make a good asset for the thin ‘high risk’ slice of your overall portfolio. Returns generated here can be skimmed off into safer assets, while any losses can be limited to the small amount you invest here.
Gold, on the other hand, tends to mirror the rest of the economy in how it performs. In other words, when the economy is thriving, gold will tend to lose value or stagnate. But when stock markets crash and uncertainty looms, gold tends to pile on value, as it is the asset of last resort. Gold therefore makes an ideal counterweight to risky commodities such as oil, so bear this in mind when balancing out your portfolio.
So far we haven’t mentioned the investment that used to be on everyone’s lips: Bitcoin and other cryptocurrencies. Over the years cryptocurrencies have proved among the most volatile assets of all, with a stellar peak around 2018 followed by a very rough ride. There is very little chance that we will see a repeat of the period when Bitcoin made millionaires overnight, though over the past two years it has shown a total of 15% growth overall, albeit with many ups and downs. IFAs don’t advise on cryptocurrency, so you handle it at your own risk. File under ‘highly volatile’.
Not an asset class as such, but a pension fund can double as a medium-term investment for people approaching pension-freedom age. Pensions can be accessed at any age from 55 onwards, so if you’re looking at investments for the next 5 to 10 years and are in your late 40s or older, your pension shouldn’t be discounted as an option.
Everything you pay in will benefit from an effective 25% boost thanks to tax relief, and all growth is tax-free too. Bear in mind that there are downsides to taking your pension early, so take advice before choosing this option.
If you find yourself with excess cash savings or income, then however you decide to invest this, make sure you have a strategy. Don’t just go for the route that seems to offer the highest returns, as the corresponding risks might not be suited to your goals. For more insight on this, check out our guide on How to Invest £100,000.
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