With higher interest rates, should you keep savings in cash, or invest?

Interest rates in the UK are at their highest for 15 years, meaning that some top-paying savings accounts are offering more than 5% p.a. with one-year fixed term accounts going as high as 6.1%.¹

While this is bad news for mortgages and other debt, it is good news for anyone with savings, and we are increasingly being asked whether it is better to hold onto cash deposits rather than invest in potentially volatile assets like shares.

To help answer this tricky question, here’s our look into the relative advantages and disadvantages of savings and investments.

Cash savings – the plus points

• Cash is offering high interest rates, giving an attractive return which will not lose value in nominal terms.
• Cash rates will/should increase as interest rates rise, although this will likely not apply to fixed-term accounts.
• If inflation proves stubborn and interest rates need to move higher or stay high for a while, then cash rates should benefit.
• If inflation falls below cash rates, then investors will make gains in real terms.
• Cash can help shelter portfolios from short-term market volatility.

On the other hand…

• Cash rates will decrease when interest rates fall, reducing returns; and providers will likely be very fast to cut rates on products as interest rates come down.
• Cash must be held on account or invested in a money market fund for the whole year to capture the full rate.
• Some accounts only allow a limited amount to be invested each month, up to a maximum level for the year. This means in the first year you will not receive the cash rate on the full amount allowed, but only on the amount that is invested each month. This rate will likely be reduced if rates fall.

In favour of investments

• Yields on bonds are always typically higher than those from cash. The UK 10-year government bond yield is expected to be 5.33% by the end of March 2024² and corporate bond markets (debt issued by companies rather than governments) even more than this; closer to 6% for the UK corporate bond market.
• Bond yields will likely fall as interest rates drop and this should increase bond prices therefore adding capital growth. For example, a 1% fall in yields should lead to a capital gain of c.10% for a 10-year bond.
• Investing in cash will reduce/remove the participation in any continued market recovery, in bonds or equities. These asset classes have proved to deliver returns ahead of cash rates over the long term.
• Being out of the market on days when shares move up very sharply dramatically reduces the long term returns for portfolios. These days often happen when markets are volatile, seeing big moves up on days after a big move down.  Consistently timing the market correctly is impossible so you must stay invested, taking the rough with the smooth.

Other things to take into account about holding cash:

• Inflation diminishes the value of your money in real terms.
• Cash rates are unlikely to be consistently higher than inflation which is currently at 6.7% in the UK³.
• Falling inflation, which is expected despite recent figures, will reduce the need for high interest rates, and will therefore lead to lower cash rates.
• Higher interest rates increase the chances of a recession and destabilising the housing market, which would increase the likelihood for interest rate cuts and therefore lower cash rates.

The decision to hold cash deposits or invest depends largely on your appetite for risk, your personal circumstances and the anticipated time horizon before needing to spend your savings or investments.

It can help to talk things over with a professional IFA, who can explain all the different angles in plain English, and find out what you’re hoping to achieve with your money.  There are also tax advantages to certain types of investments, and your adviser can talk you through the different options, and guide you towards the right decision for you.  Find a Talis IFA here.

Sources:

1. Best savings accounts: 5.2% easy access or 6.1% fixed rates (moneysavingexpert.com) (accessed 17/10/23)
2. United Kingdom 10 Years Bond – Forecast (worldgovernmentbonds.com) (accessed 17/10/23)
3. Home | Bank of England (accessed 17/10/23)

The value of your investments can go down as well as up, and you may get back less than you invested.