Are low interest rates hurting my finances?

Now interest rates have reached an all-time low, it’s time savers cast a critical eye over their savings accounts and consider whether there is a more rewarding home for their cash.

Many of us know that switching bank accounts can bring a more generous interest rate on savings. We know, and yet we – mostly – do nothing.

Just look at Clydesdale and Yorkshire Bank, who in 2017 offered £250 to new customers, and in 2019 pulled the offer after very little take-up.

According to YouGov, one in five Brits have considered switching current account and still they’ve failed to go through with it. Asked why, almost half felt it would be too much hassle.

Poor savings rates and the perceived complexity of switching accounts means that many savers are essentially losing money. One in five people would rather go to the dentist than switch bank accounts. But for many, cash accounts are making them poorer.

The good news though is that switching accounts can be a relatively straightforward experience. Even switching from a cash to a stocks and shares ISA is relatively easy.

Has my interest rate changed?

The interest rate you earn on your savings can change, sometimes dramatically, and often times without your knowledge.

The Bank of England pegged its base rate – the mother of all interest rates – at 0.1% in May, with the expectation that interest rates will rise only a little over the next three years. Keeping interest rates at such historic lows will hit savers, many of whom have already watched the interest rate on their savings tumble in recent months.

Research by moneyfacts.co.uk shows that in the three months since coronavirus’s impact on the UK economy was felt in March, the average rate on an easy access account halved, from 0.6% 2020 to 0.3%. Not only is this a more dramatic decline than during the financial crash, it comes at a time when interest rates were much lower to begin with.

Santander’s 123 account was one of several cash savings accounts that slashed rates from 1.5% to 1% back in January. The sting in the tail, as we mentioned in our blog post at the time, was the monthly fee customers paid just to hold an account.

Today, that same account offers a 0.6% interest rate. For context, that’s half the UK inflation rate, as of April 2020, but far superior to NatWest’s instant-access primary savings account, which, as of June 8, pays just 0.01%.

Am I making the most of my tax breaks?

Depending on your situation, a few simple steps could have a big impact on your wealth.

For starters, it’s smart to use as much of your ISA allowance as possible. As of the 2020/21 tax year, up to £20,000 can be put away tax free across different types of ISAs. You’ll get another allowance in the new tax year, but your current allowance won’t roll over. Our advice: Use it or lose it.

Once in an ISA, and assuming your contributions fall within the £20,000 annual allowance, your money is tax-free for life. Whether you  invest in stocks and shares, save in cash, or do a bit of both, ISAs are an easy, tax-efficient way to make your money work harder for you.

Should I consider investing?

“Savings” and “investments” might seem similar to the uninitiated, but they are very different entities. Where savings grow in line with current interest rates, investments are subject to market movements.

It’s tricky to compare the two, but investing may offer growth that actually outpaces inflation and gains real value over time, particularly over the long-term.

Looking at data from developed equity markets between 1971 and 2020, the longer you invest, the less likely you are to lose money.

Source: Macrobond; MSCI World Equity Mid and MSCI Large Cap Total Return in GBP, 1 January 1971-20 May 2020

Just remember, nothing is guaranteed in the world of investments. Pursuing higher returns means that you take higher risks, so make sure you consider all the facts carefully before moving your money.

Generally speaking, cash is a safe bet for short-term savings. If there’s a possibility you’ll need cash for an emergency or you’re saving for a specific goal within the next few years, keeping your money in a cash ISA – even one with a low interest rate – may be a better option than a stocks and shares ISA.

If you are comfortable with the idea that your investments can go down as well as up, investing your money in stocks and shares could potentially offer higher returns than interest rates on a cash ISA.

Am I underplaying the power of compounding?

The concept of compounding is very simple, and very powerful.

In the first year of investing, you may generate returns on your initial investment, while in the second year, you invest your initial investment plus any potential returns to generate further returns on the total. Reinvesting any returns on your returns means your money can enjoy exponential growth. Of course, investing is subject to market ups and downs, and there’s a risk you’ll lose the money you’ve put in.

Watch: What is compounding?

The point to remember is that even a small investment could grow to become something quite substantial over the long-term, thanks to the effect of compounding. Sticking your money under a metaphorical mattress might feel reassuring but it may not grow your wealth to meet your financial objectives.

See the power of compounding for yourself: Try our compound returns calculator

When you understand the powerful impact just a few percentage points could have on long-term compounding returns, the case for investing cash savings looks pretty compelling. All the more so while interest rates are low.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice. Past and future performance indicators are not reliable indicators of future performance.