Saving vs Investing

Savings rates are rising, but investing is still the best long-term route for your money

It seems strange to think that just over a year ago, at the beginning of December 2021, the main interest rate set by the Bank of England was 0.1%^1, its lowest in more than 300 years of the Bank’s history. In the decade preceding this, savers just couldn’t catch a break – interest rates remained glued to the floor as central banks around the world attempted to stimulate their economies out of slowdowns generated by the financial crisis and Covid, by making money cheap to borrow.

And then 2022 arrived, bringing with it a sudden and stunning spike in inflation. Concerned by the potentially devastating impact high inflation can have on the economy and society more widely, the Bank of England quickly began ratcheting up its main rate of interest, most recently in December by 0.5% to 3.5%.² It appears more increases are likely in 2023.

For those thinking about what to do with their savings, it begs the question: why invest in the stock markets given the risks involved; with juicier savings rates, surely interest-baring accounts are a much better alternative? While it’s likely markets will remain volatile for the moment, it’s important to note that savings are also suffering under the yoke of inflation and actually experiencing negative real returns. In our view, cash may still be best for short term financial goals, however over the long term, it’s worth investors considering stock market investing for building wealth.  

Inflation remains painfully high

Over the past 18 months, inflation has been rising in earnest. Initially, as the economy started to emerge from the misery of Covid, lethargic and sluggish supply chains hindered the supply of certain goods such as clothes and food, restricting availability and raising prices. Then, in February 2022, Russia invaded Ukraine, with resulting sanctions sharply elevating the price of oil, gas, and other commodities.

Taken together, these pressures have fed into prices more broadly, lifting inflation to levels not seen in four decades. The latest Consumer Prices Index (CPI – a measure of inflation) reading indicated a 10.5%³ average price rise in December. 

Central bankers have been blindsided by the shift. Over the course of the previous decade, since the onset of the global financial crisis, central banks pumped money into the global economy to the tune of trillions of dollars to try to stimulate growth. Received wisdom dictated that this should have been very inflationary, and yet inflation didn’t budge an inch.

Over time, economists started to become convinced that the forces of globalisation were so powerful, they were keeping inflation anchored tightly to the floor. As it turns out, it seems those forces have found more than a match.

All told, the sea change has propelled central bankers to reach into their monetary toolbox to deal with the problem. On hand in particular have been the levers of interest rates.

Bringing inflation down

High inflation is the ogre central bankers fear the most. Small levels of price increases are seen as healthy for an economy, but too high and it starts to crimp consumer spending and erode the value of wealth. Society feels its impact particularly strongly, especially those on lower incomes. What’s more, if it remains high for long enough, it can become entrenched - feeding on itself through our expectations for inflation in the future.

One of the key objectives of the Bank of England, is to maintain stable prices within the economy, aiming for a constant rate of 2% inflation. To achieve this, it uses the Bank Rate. This is the rate of interest commercial banks and financial institutions are paid for parking excess cash at the Bank of England overnight.

If the Bank Rate is increased, the impact ripples through the financial sector and wider economy. Commercial banks will charge businesses and households more for taking out loans, while at the same time rewarding savers more for tucking their money away.

This slows borrowing and consumer spending, which in turn, discourages businesses from raising their prices, cooling inflation. For savers, banks will pass on Bank Rate rises, to varying degrees, through the savings rates they offer on interest-bearing accounts.

In the chart, we can see the rapid pace of interest rate4 rises this year.

But it’s important to note that, given that inflation has still not materially reduced yet, high rates are not currently translating into high ‘real’ savings rates. Let’s use an example.

Inflation impact on savings

According to Moneyfacts⁵, a data provider, the best rate on an easy-access account at the moment is 3.2%. With inflation at 10.5%, this means on £10,000 of savings you would receive a loss of £730 a year in real terms. If you happen to have more time on your hands and are able fix your money for five years to get a better rate, then currently the best five-year fixed rate deal on the market is 4.55%. With £10,000 of savings, that’s a loss of £595 a year in real terms.

The FCA estimates there are 9.7 million Britons with more than £10,000 sitting in cash and almost no investments.⁶ Bar the three-to-six months of costs that we are generally advised to keep as a rainy-day fund, it means many of us have excess savings that are facing a loss in real terms.

While markets remain volatile on account of the economic gloom, for those with near-term financial goals or little appetite for risk, savings are an appealing option. But for those with longer-term goals, it’s worth remembering that the real rates of return we are receiving at the moment are deeply negative, meaning the spending power and value of our savings are falling over time.

Alliance Trust for long-term investing

Under the same cosh as the rest of us, companies are experiencing inflation in the form of high energy prices, more expensive loans, and rising wages. However, certain businesses in strong competitive positions with attractive profit margins and must-have products and services are well placed to pass on these costs to consumers without affecting their sales too much. This is known as pricing power, and it enables firms to continue growing their profits and delivering strong returns, regardless of the inflationary environment.

These are among the types of companies that the stock pickers at Alliance Trust have sought for the Portfolio. As a result, investing in a portfolio of shares such as Alliance Trust could represent an attractive route to beating inflation over the long term. What is more, while stock markets may continue to be volatile this year, low stock market values give investors an opportunity to enter the market at more attractive share prices, compared to the elevated levels that prevailed at the peak.

Marcus De Silva, Freelance Investment Writer

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at February 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.