2 July 2020
Where to stash cash?
The hunt for a return
By Frank O’Nomics
It is the ultimate financial Catch-22. You are cautious about your spending plans, job prospects and the outlook for your investments, all of which suggests that you should be holding a large buffer in cash. The problem is that cash holdings currently produce next to no return – and once inflation is taken into account that return is negative; the longer you hold cash the less it is worth. The scenario looks bleak for the cautious, but Ssh! There may be still some relatively attractive opportunities in rather obvious places.
Caution is the watchword for many. The number of people worried about losing their jobs is at an unprecedented level; some 6 million on furlough have expressed this concern. Even those confident that they will successfully come off furlough are not sure when this will be, meaning a 20% loss of income has to be accounted for over an indeterminate period. Consider also the recently retired or soon to retire – those looking to start taking their pensions. Many of these will be reluctant to do so now, at a point when the value of their fund has fallen significantly, and prefer to use up a cash buffer while they await a recovery in fund values.
Larger than normal cash balances are then essential, but where can they be held to generate the best return? Savings and deposit rates offered by clearing banks for instant access give a 0.01-0.02% return (just 2p for each £100 over the course of a year), although it is still possible to get a little more at some building societies; Coventry BS for example offers 0.55%. Perhaps the best alternative recently has been to open an account with the online bank Marcus. This was set up by Goldman Sachs in 2018 and originally offered a market-beating rate of 1.5% for instant access. Recent falls in interest rates have meant that this rate has now slipped to 1.05% and, while still competitive, the account has been closed to new customers – a result of the bank taking in so much money that it risked overshooting their regulatory limit of £25bn. That boat, it seems, has sailed.
For those prepared to put their money on deposit for a fixed term it is possible to get more, around 0.8-0.9% for a year, and a little over 1% for 2 years. Most of these rates are from names that you may not have heard of but, as long as you keep the sum invested in each bank below the Financial Service Compensation Scheme limit of £85,000, your money is safe. Even these rates may not be around for long. One year ago Paragon Bank was offering a one-year fixed rate deposit at a rate of 1.95%, but now anyone whose deposit is maturing is only offered 0.9% for another year. With official interest rates set to stay very low for a long time it would not be surprising to see that one year rate halve again over next 12 months.
One alternative that many should consider is the government. No, not UK government bonds (gilts), where the yields are negative for shorter than 5yr maturities, but in the coffers of National Savings and Investment. NS&I is 100% backed by the UK Treasury and each year is set a sum to raise to help cover the National Debt. Last year this amount was £11bn, but the cap was cut to £6bn in April. This limit will have been easily hit given that their instant access Income bonds pay 1.16% on anything from £500 to £1mn. Fortunately, the “exceptional market conditions” have led the Treasury to suspend the cap and the account is still open. It might be worth considering using the facility before the Treasury brings down the shutters. One alternative is premium bonds, also issued by NS&I and with an instant access facility, which generate an average payout of 1.4%. The problem here is that the return in any single year could be widely different to the average.
All of the accounts covered so far, except premium bond winnings, are subject to tax. For those that pay higher rate tax the returns cited are almost halved. Not surprisingly then that many have been putting money into a tax-free cash Individual Savings Account (ISA). Last year, for the first time in 5 years, the numbers subscribing to an ISA increased, with a further 1.1mn accounts opened, and the total amount saved rose by £2.3bn to £67bn. 76% of all these subscriptions went into cash, rather than equity ISAs. Investors would rather be earning 0.9% cash free than risking their money on the stock market, and they can also do this with the addition of government security given that the NS&I also offer such a product. Again, 0.9% does not sound generous, even when tax-free, but it does offer comfort when accompanied by security and a current inflation match (CPI is also 0.9%).
The much talked about peer-to-peer lending can generate much greater returns on cash, but they are outside the scope of this article. People who are facing an uncertain future need to ensure that their money is in a safe place and available to them at the point when they are most likely to need it. Taking the credit risk of other individuals, or property companies, does not satisfy either criterion.
It is very easy to dismiss the interest rates offered on cash as being unimportant given that they are so low. There is no doubt that the interest rate offered on instant access accounts is unexciting, but given the increased need for a cash buffer and the volatility of stock markets, boring can sometimes be quite comforting.