Getting the Best Possible Income from Your Cash Savings

How much is enough to provide diversification and liquidity while lowering the volatility of a portfolio? And how can you ensure that the little interest you earn is not eroded by inflation?

Kara Gammell 8 October, 2015 | 8:30AM
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This article is part of Morningstar’s Guide to Income Investing. Whether you are looking grow your pension pot, or invest for retirement income, this week we have all the news, information and education you need.

It may feel counter-intuitive while interest rates are so low, but holding cash is an essential part of any investment strategy. Financial experts agree that people should put aside a minimum of three months of earnings to cover themselves in case of an emergency such as job loss, but how much cash should investors actually hold?

How much is enough to provide diversification and liquidity while lowering the volatility of a portfolio?

It all depends on your personal circumstances, said Frances Kemp, an adviser at Nurture Financial Planning.

“It will typically vary from around 2% to 3% depending on your requirements, unless of course you are planning to take an income,” she said.

Kemp pointed out that while savers can benefit from security in absolute terms if they hold money in cash, with interest rates still at historic lows, they are continuing to lose money in real terms – so getting the balance right is crucial.

“Investors should be careful not to hold too much as cash because over time inflation will wear away what tiny interest is accrued, leading to a real loss,” she said.

Savings Rates “Lowest on Record”

Activity in the savings market has been dismal for some time, but it's recently taken an even more unfortunate downturn. Figures from Moneyfacts.co.uk show that the average easy access ISA rate now stands at a paltry 1.11% – the lowest rate on record.

“Savings rates have been on a fast decline for several years with the Funding for Lending Scheme the catalyst for the flood of rate cuts, especially for those with existing savings accounts,” said Susan Hannums, director at SavingsChampion.co.uk.

“This highlights the desperate need for savings to switch their accounts when they no longer remain competitive, as in the current climate you’re almost guaranteed your rate will fall over time.”

Though there may be little incentive to save your hard-earned cash with accounts offering interest rates below inflation, cash ISAs can still come in handy to a canny investor looking to ring-fence funds.

If you want to make the most of your savings, there are competitive deals available; you just need to know where to look.

Shop Around for the Best Rates

Using a comparison website is often the easiest way to find the best deal. To get a complete list of the best-paying accounts from all UK banks, select "all accounts" when doing your search, not just those that pay a commission to be promoted. Then compare accounts with sites such as moneysupermarket.com, uSwitch.com and moneyfacts.co.uk.

Another way to stay on top of your interest rates is to use an online savings account monitor such as Rate Tracker; a free service offered by SavingsChampion.co.uk, that reminds you when your interest rate is set to fall.

Bear in mind that you get a higher rate for the longer-term, fixed-rate accounts.

The Best ISAs on the Market

If you are happy locking your money away for five years, for instance, United Bank’s Five Year Fixed ISA pays 2.55%. Available for those with a minimum deposit of £2,000, funds in this account can be accessed on closure only, subject to a penalty and transfers in are permitted.

Medium-term savers should look to Virgin Money’s Fixed Rate Cash E-ISA Issue 135 that pays 2.25%. Account can be opened with a minimum deposit of £1, accepts transfers and withdrawals are allowed, subject to 120 days loss of interest.

If you are looking to fix your interest rate for just a year, the best deal comes from Virgin Money’s 1 Year Fixed Rate ISA Issue 70/E-ISA Issue 141 and pays 1.81%. This account can be opened with a minimum balance of £1, permits withdrawals, subject to 60 days loss of interest and accepts transfers in.

If you prefer instant access, the best ISA is Nationwide Building Society’s Flexclusive ISA (Issue 9) paying 1.6% on balances above £1.

Transfers in are allowed as are unlimited withdrawals and deposits up to your allowance, but savers will have a Flex account to be eligible for the account.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Kara Gammell

Kara Gammell  is a freelance journalist and author, specialising in personal finance and consumer issues, writing for Morningstar.co.uk