Over 14m working age adults in Britain are not saving at all, while some 26m do not hold adequate rainy day or pension savings.

Even those who are setting money to one side are potentially missing out on billions of pounds of valuable income by holding too much money in cash.

Those were the headline findings from a recent Social Market Foundation report on the state of the UK savings nation.

According to the report, savers hold more than £200bn in cash above and beyond their ‘rainy day’ needs – which is defined as three months’ worth of income. To put that in context, the FTSE 100 has risen by 47% in real terms over the last five years, equivalent to £94bn (before charges) if all that spare money had been invested.

Clearly that figure assumes 100% stock market exposure, which may not fit your risk appetite, and past performance is of course no guide to the future.

But with interest rates trundling along at 0.25%, Cash ISAs offering paltry returns and inflation returning to the economy (and currently standing at 2.6%), investors should consider taking some risk in order to prevent the real value of their savings being eroded away.

Pensions

If you want to save for retirement, pensions remain the best option for many people. Even if you’re only saving a few pounds a month, that money will benefit from an automatic bonus of 25% if you’re a basic rate taxpayer through tax relief – and you can claim extra relief through your annual tax return if you’re a higher-rate taxpayer. It will also receive a boost from the magic of compound growth, described by Albert Einstein as ‘the Eighth Wonder of the World’.

Your first port of call should be your workplace pension. Automatic enrolment reforms currently being introduced mean that, by 2019, all employers will have to match your first 3% of contributions – extra free money on top of the tax relief on offer. If you want to save beyond this (and for most people the total minimum auto-enrolment minimum will not be enough to fund a decent retirement), you can top-up your workplace scheme or open a more flexible Self Invested Personal Pension (SIPP).

Anyone considering saving in a pension needs to remember the money will be locked away until they are 55, with 25% available tax-free after this point and the rest taxed in the same way as income.

Fund picks for pension savers

Fidelity World Index (GB00B8075673) – This is a passive, or tracker, fund. The annual cost of only 0.15% and widely diversified portfolio make it a good long term holding for young savers to start their portfolio with.

Standard Life Global Smaller Companies (GB00B7KVX245) - Assuming the investor has very long time horizon, smaller companies can be a great place to invest. While higher risk, the long time horizon is ideal, particularly when investing on a monthly basis

Lifetime ISA

For lots of younger people their main priority for any spare cash will be saving a deposit to buy their first home. The Lifetime ISA (LISA), launched by the Government in April this year, is an attractive option for people in this position.

You can save up to £4,000 a year in a LISA and receive a 25% bonus, worth up to £1,000. You can then take the money out tax-free if you’re using it as a deposit on your first home, provided it’s worth £450,000 or less.

You can also access your pot tax-free from age 60 or if you are terminally ill, but any other early withdrawals will be whacked with a 25% penalty on the entire withdrawal – which could mean you’ll get back less than you put in.

How you invest your LISA money depends on when you plan to access your pot. Someone who thinks they’ll need 20 years to save to buy a house should be able to absorb more investment risk than somebody investing for a shorter period of, say, five years.

Fund pick for LISA savers

Baillie Gifford Global Alpha (GB00B61DJ021) - This fund has a reputation for excellent stock picking from its strong team and the long-term approach could suit someone’s LISA – any investment in shares is really a 10-year plan, although this does mean the investor would need to carefully assess the risks if and when they get to the stage of wanting to access their cash.

Stocks and Shares ISA

If your priority is ease of access then an ISA is a good option. You can put in up to £20,000 a year, your money grows tax-free and you can take it out at any time without penalty.

But with Cash ISAs offering interest rates well below inflation, many people would be well advised to consider using a stocks and shares ISA instead in order to at least protect their spending power.

How you invest your money will, again, depend on how soon you might need to access it and your willingness to tolerate risk.

Fund pick for ISA savers

Evenlode Income (GB00B40SMR25) – this fund, managed by Hugh Yarrow, looks at companies that can grow their dividends in a sustainable way which should over time provide some inflation protection.

Tom Selby,

Senior Analyst, AJ Bell

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