Three Big Problems With Savings Accounts

The Bank of England hiked its base rate last week, giving savers reason to celebrate. However, they still have to face these problems.

Last Thursday, the Bank of England raised its base rate from 4.5% to 4.75% a year, which came as a shock to Britain's over-burdened borrowers.

However, this is good news for tens of millions of savers, who expect to receive higher returns on their spare cash when banks and building societies push up savings rates. UK-resident savers have a cash pot totalling £580 billion, so an across-the-board rate rise of 0.25% means an extra £1.45 billion a year before tax in our pockets, which is well worth having!

Problem one: sneaky providers have been cutting savings rates

Alas, according to independent financial researcher Moneyfacts, many savings providers have cut their savings rates in 2006, even though the base rate remained unchanged at 4.5% for almost a year (from 4 August 2005 to 2 August 2006). Indeed, since the start of 2006, more than forty providers have cut savings rates at least once, in some cases by half a percentage point. So, despite this base-rate rise, thanks to these pre-emptive savings rate cuts, millions of savers will see little or no change to their savings rates -- leaving banks and building societies the clear winners!

Problem two: savings rates are barely keeping up with inflation

As I warned here, inflation (rising prices) is creeping up, which is bad news for savers. In fact, the government's preferred measure of price changes, the Consumer Prices Index (CPI), currently stands at 2.5% a year. Worryingly, average annual savings rates are barely above this level, at just 2.69% for instant-access/no-notice accounts. Thus, a large number of savers are seeing their money shrink each year, simply because their savings are growing at a slower rate than prices are rising. Ouch!

Problem three: far too much choice leads to inaction

According to Moneyfacts, savers can choose from over five hundred different instant-access or no-notice accounts (and almost three hundred notice accounts). This huge choice of accounts leaves many savers overwhelmed, which leads to "paralysis by analysis". What's more, savings providers are constantly launching and withdrawing accounts, which leads to a high turnover of available accounts and, therefore, huge confusion among savers.

As proof, I give you a study published in this month's Journal of Financial Regulation and Compliance by the University of East Anglia and the University of Surrey. This research revealed that 1,018 new savings accounts were introduced in the UK between 1993 and 2004, while 769 accounts were withdrawn over the same period. This study concluded that the main reason behind this high turnover of accounts is "maximising shareholder value", which means that "confusion marketing" is purely driven by the desire to make ever-greater profits.

To sum up, millions of savers are fearful of choosing between hundreds of similar accounts, so they opt to do nothing and leave their nest egg or emergency fund where it is. Sadly, this is almost always a bad mistake, as boosting your savings rate by, say, two percentage points means an extra £100 a year before tax for each £5,000 on deposit. That's a terrific return for around fifteen minutes of effort!

Finally, all three problems mentioned above can be solved with one simple act: switching your savings to a Best Buy high-interest savings account. One which stands out from the crowd is the ICICI Bank HiSAVE account, which pays 5.15% AER on £1+, with no strings attached.

More: Want a great rate? Compare these savings accounts | The Saver's Greatest Enemies!