Why investing your wealth could still be crucial as interest rates rise
Released On 28th Mar 2024
Cash savings are a relatively simple way to hold your wealth. You deposit the funds and leave them there, possibly earning interest, until you need them again.
You don’t usually assume the same level of risk that you might with investing, and it’s easy to open and start using a cash savings account. Additionally, if you save in a Cash ISA, you don’t normally pay tax on any interest you generate.
Cash savings may be even more attractive right now as interest rates have risen considerably in the last year or so. This could mean that you generate more growth on cash savings than you would have done in the recent past.
However, there may be such a thing as too much cash and if you favour cash over investments, you could be missing valuable opportunities to grow your wealth.
The Bank of England raised its base rate multiple times to combat inflation
High inflation and increased living costs have never been far from the headlines in the last few years.
Although inflation has fallen in recent months, it reached 11.1% in October 2022, according to the Office for National Statistics (ONS).
The Bank of England (BoE) raised its base rate 14 consecutive times in response to high inflation. It does this with the aim of increasing borrowing costs and making savings rates more attractive to discourage spending and bring prices down, thereby reducing inflation.
As a result of base rate increases, cash savings interest rates also rose.
As of 1 March 2024, Moneyfacts reports that the best one-year fixed-term Cash ISA interest rate was 5.25%.
This is a significant increase on the best fixed-term Cash ISA interest rate of 1.31% reported by Morningstar in March 2020.
So, you might think that holding your wealth in cash is beneficial right now because you can take advantage of increased interest rates but there are potential downsides to cash that you may want to consider.
Inflation could dampen the growth on your cash savings
It’s important to consider the effects of inflation when deciding if a cash savings account is the most sensible place for your wealth.
According to the ONS, inflation was 4% in the 12 months to January 2024.
When inflation is 4%, the same goods and services that you could buy with £1,000 last year now theoretically cost £1,040 a year later.
If you put £1,000 into a savings account with an interest rate of 5.25% – the best one-year fixed-term Cash ISA interest rate on 29 February 2024, according to Moneyfacts – you would have £1,052.50.
So, your savings are growing faster than the rate of inflation and you can likely purchase more than you would have been able to the previous year.
However, your real-terms growth – your interest rate minus the rate of inflation – is only 1.25%. As such, inflation could dampen the level of growth you see from your cash savings, even when interest rates are high.
Bear in mind that inflation reached 11.1% in October 2022 and has been much higher than this in the past.
If inflation rises higher than the interest rate on your cash savings account in the future, your wealth suddenly starts losing value in real terms.
This could make it more difficult to reach your long-term financial goals. Fortunately, investing may help you combat inflation.
Investing could help you generate more long-term growth
An emergency fund can be a useful buffer against financial shocks, so it may be beneficial to hold some cash. People often recommend two to three months’ worth of expenses as a guide.
Your emergency fund is there to give you peace of mind, so consider what level of cash savings would make you feel comfortable and secure.
Once you have this amount saved, you may want to invest any additional funds to build wealth for the future. That’s because investment returns may outpace inflation and beat the interest you generate on cash.
For example, according to Finder, the average variable Cash ISA interest rate in the 10 years to January 2024 was 2.77%.
In comparison, data from Curvo shows that the FTSE 100 had a total return of 71.3% in the last 10 years, with an average annualised return of 5.5%.
That said, it is important that you take a long-term approach to investing.
The same figures from Curvo show that the FTSE 100 only returned to 2.1% in the last year. This may be because markets tend to fluctuate and we are currently experiencing a period of volatility.
As a result, if you only left the money for a year, you would likely have been better off putting it in a savings account rather than investing in the stock market.
Fortunately, markets tend to recover and continue growing after periods of volatility, so if you leave your wealth invested for the long term, you may be more likely to see returns that beat cash and inflation.
Indeed, the data from Curvo reveals that the total return from the FTSE 100 over the last 20 years was 242.2%, with an average annualised return of 6.3%.
Provided you take a long-term approach, investing your wealth instead of leaving it in a cash savings account could mean that you see more growth and you may find it easier to achieve your financial goals.
Get in touch
Get in touch or email us at advice@milstedlangdon.co.uk for more information.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.