£306 billion earns no interest: you need a savings plan

Saving is hard work. With prices rising on all sides, we’re going all-out to squirrel cash away to protect us from the unexpected and build towards the things we really want in life. So, when we’re putting a shift in, it’s disappointing if our savings aren’t working as hard on our behalf.

The ONS’ household saving ratio – the percentage of total household money that is available for saving – in the first quarter of this year was 8.9%, which demonstrates an impressive commitment to saving. Excluding the pandemic, the average ratio for the past 10 years was 6.7%. However, where we’re putting this money leaves something to be desired.

There’s a huge pile of cash sitting in accounts paying no interest at all – an eyewatering £306 billion, which is up £6.9 billion in a year. If this money was shifted into easy-access savings accounts earning 4% in a year, we could collectively be £12.5 billion a year better off.

We’re not only missing out on this interest, we’re also losing the spending power of our cash over time, as inflation chews its way through our money. Leaving this money languishing in your current account, or sitting around in ancient savings accounts paying nothing, means your money is less and less valuable with each passing month. We need to escape the current account trap and move money into savings or investments.

However, before making the move, it’s vital to consider the right home for each chunk of your savings, and there are five building blocks to a sensible savings strategy.

1. Consider the right types of account

Easy-access accounts are the most sensible home for your emergency savings, so you can get your hands on the money quickly in a crisis. When you’re working age, you should be aiming towards a pot that’s big enough to cover three to six months’ worth of essential spending. In retirement this rises to one to three years’ worth.

But easy-access isn’t the only game in town, and savers are missing a huge opportunity by keeping the lion’s share of all their savings in these accounts. If you need some of this money within the next five years, but not immediately, you can tie it up for a fixed period – of anything from a few months to five years. In return you will get a guaranteed interest rate, which tends to be more generous than the easy-access rates on offer.

You can open several accounts, for different purposes, fixed for different periods. If you use a cash savings hub, you can hold different accounts with different banks in one place, which makes it much easier to keep an eye on everything.

2. Shop around

Not all easy-access is equal. The Bank of England data shows the average account paying just 1.6%, whereas by excluding accounts with restrictions and very short-term bonuses you can make up to 4.55% on easy-access savings. Likewise, the fixed rate market is pricing in rate rises, so you can make 5% over three or five years, and almost as much over one and two. It’s vital to shop around for a more rewarding home for your money. Use comparison sites or cash savings hubs to find and compare the best rates available on the market.

3. Consider tax

For those with large cash balances and higher rate taxpayers, it’s also important to consider Cash ISAs. You may not be able to get quite as much in interest from an ISA as the very top savings accounts, but after tax, the protection afforded by the ISA could mean you end up better off.

It depends what rate of tax you pay and how much interest you have from other sources. That’s because the personal savings allowance means the first chunk of interest each year is tax-free. For basic rate taxpayers this is £1,000, for higher rate taxpayers it’s £500, and it disappears entirely for additional rate taxpayers. Interest received annually above these levels is taxable and could benefit from being held in an ISA.

4. Don’t overlook money market funds

This is an investment rather than a savings account, but they typically pay a higher rate of interest than savings accounts at banks, at a lower level of risk than equity funds. Money market funds put their money in cash and cash-like investments, such as short-term loans and high-quality bonds, which makes them a good instrument to park cash in and earn a steady return. Some people may also use money market funds as a lower-risk entry point to start their investing journey.

5. Consider investing more broadly

Once you have your emergency savings and cash you need for planned expenses over the next five years, you should think about investing any excess for the longer term of five to 10 years or more. The value of your investments will rise and fall over the short term, but as long as you have a longer time horizon, you should have the opportunity to ride this out and take advantage of the long-term growth potential of investments.