During the 1980s the average savings rate was 8.95%; during the 1990s 6.95%, and by the 2000s this had dropped to 4.40%
An article on the BBC Website had the headline “Savers ‘devastated’ in August as rates fall below 0.5%” (31 August 2016). It explained that following the cut in interest rates the average cash savings plan was offering between 0.49% for an Easy Access Account and 1.69% for a Five-Year Fixed Bond.
The implication was that this was a shock for many.
Over the last couple of years, the number of articles highlighting the “devastation” for savers has intensified, and the suggestion is that this is the only means of saving.
In this blog we want to explore the facts, and why perhaps we seem to be trapped in an 80s time warp!
During the 1980s the average savings rate was 8.95%; during the 1990s 6.95%, and by the 2000s this had dropped to 4.40%. Since 2010 this has fallen further to 1.92%. (source swanlowpark.co.uk)
Going back through history it’s unsurprising that the peaks in saving rates came when interest rates were at their highest.
In the past when someone came to retirement, their final salary scheme (guaranteed pension) gave them a large lump sum; and it seemed to make sense to put it in cash using the interest to provide an additional income.
There were two main reasons for this and both were interconnected. Firstly, life expectancy in retirement was not considered to be long (harsh but true)! Secondly there was a feeling that preservation of capital was the most important aspect of financial planning.
As an example if a pension scheme paid a tax free lump sum of £50,000 (in addition to the guaranteed pension) during the 1980s, this would have provided on average an income (through receipt of interest) of £4,475 per annum and the capital would remain protected.
But interestingly as life expectancy has improved, savings rates have fallen. In fact, saving rates have been falling since 1998 (although there was a brief spike in 2007) dropping to their current level of just 0.49%.
And yet it seems despite all the evidence we are still stuck with the idea that rates will improve to these levels once more.
It is clear that cash can no longer be seen as a means of providing income, although it can be used a means of protecting capital, and this has been the case for many years. However, capital preservation becomes less important when considering that retirement can last in excess of 20 years.
The point is that in today’s terms, is using cash for a retirement period of 20 years plus the appropriate strategy?
Away from savings rates it is worth reflecting on interest rates.
During the 1980s interest rates went up and down like a yoyo; starting at 17% and ending the decade at 14.875%. During the 1990s they went from 14.875% to 5.50%; and by 2009 they had dropped to 0.50%.
In fact, the last time interest rates went up was on 5 July 2007; they dropped to 0.50% in 2009 and stayed there until they went down to their current level of 0.25% in August (2016). That’s nearly ten years of falling or static interest rates. The reality is that interest rates could fall further but are unlikely to rise any time soon.
There is a correlation between interest rates and savings rates. If rates are low, then saving rates will be.
The ‘so called’ shock that the papers write about shouldn’t be considered such. Saving rates have been falling decade by decade so people aren’t new to this idea, but it does seem that there is an expectation they will increase again one day to previous levels.
In many cases this is just about headlines.
Cash has a place in financial planning; everyone should have an element of cash for emergencies and short term plans but beyond that it becomes questionable.
We are already seeing that if you ignore the headlines many people know that cash can no longer be used to provide an income through receipt of interest, and therefore we are seeing alternatives whether through buy to let, income-producing shares or other investment vehicles.
But the key to income is the same as any approach to investing, and that is by using diversification across asset classes to provide downside protection. By this we mean that there is risk with investments as they can go up as well as down (although different asset classes move in different directions at different times – which is what you want), but there are ways to “protect” against short term falls. You can’t totally eradicate the falls but you can lessen them through diversification.
If journalists became less fixated on cash rates, less stuck in the ideology from the 1980s (because cash saving rates are not going to change any time soon) and started to embrace change that has been happening for years, then they are in a powerful position to help educate people when it comes to investing and in particular creating an income. (But of course bad news sells!!!)
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.