Which savings account should you get?

By following these tips, you'll not only have the best savings account for any emergencies, but also beat 95% of other savers!

Savers face something of a quandry at the moment. We could put our savings in short-term accounts paying variable interest, which are currently around 3%, or lock up our money in accounts paying fixed rates of 4% to 5% over between two and five years. Alternatively, we could use inflation-linked savings accounts.

To decide, your first question might be: What's going to happen to interest rates? Your next might be: How does that compare to future inflation? You want to know if rates will rise, so you can keep your money flexible, or if inflation and rates will fall, in which case longer fixes will pay better.

However, these aren't the right questions, because we can't assuredly predict the answers. I wrote about the unreliability of forecasts in Why house price forecasts are dangerous. Using forecasts makes no sense and we need to be more thoughtful about how we choose financial products.

That's why the right questions are: How much of my money might I need quickly? And, how do I best preserve the rest?

Firstly, separate your savings

You always need a good pot of accessible cash for emergencies, and for any planned spending in the next 12 months. This could be for next Christmas, a safety net in case you lose your job, to pay for a holiday or even an expensive MOT.

You can get accessible savings through easy access cash ISAs or easy access savings accounts. The difference between these two products is mostly a matter of tax.

With ordinary savings accounts, banks automatically deduct 20% from your interest to pay to the taxman. If you're a higher-rate payer, you pay more through your tax return. However, no tax is deducted or due with cash ISAs. You may put limited amounts of new money into a cash ISA each year (currently more than £5,000). Once you withdraw money, you lose that part of your allowance forever. Transfers to other ISAs don't count as withdrawals.

Easy access interest rates are usually variable, but are sometimes fixed for a year. You want to either fix or get a deal with a decent 12-month guarantee, usually called a fixed bonus. A good bonus is typically half a percentage point or so less than the total interest rate; if the interest rate is 3% AER, you want a bonus paying around 2.5%.

To continue to earn decent interest and minimise the impact of inflation on your short-term savings, you must shop around once a year, because banks reduce interest rates pretty rapidly after that.

Watch out for:

• “variable” bonuses, which are no guarantees at all, unless they are linked to the Bank of England base rate.
• not-so-easy access, since some accounts penalise you for multiple withdrawals.

For some of the best easy access deals around, be sure to check out New market-leading easy access account.

Beyond short-term savings

But the price of easy access is less interest. Shop around and you'll greatly reduce the impact of inflation, but you won't wipe it out entirely. Some years are worse than others. Over the past year, you might have earned just 2% to 3% after tax, but inflation has been above 5%. Hence, with any extra savings you have, you need to consider better-paying options.

Many savers wheel-and-deal by guessing interest rates and inflation, and whether a long fix will work out better than keeping their money agile. Presumably, these people want to beat either inflation or, less rationally, other savers.

However, savers who try to guess the future struggle to match inflation, let alone beat it. Looking back at the accounts you could have chosen over the years, oyou'll see that you would have had to have been lucky to come out at around inflation, with the odds of beating it are very low.

You might get lucky with your guess this time round, but you have to keep getting lucky for as long as you are a saver in order to preserve what you've got.

That's why, for longer term savings, inflation-matching or inflation-beating accounts are the rational choice. Most of the time there are one or two such accounts available, either from National Savings and Investments, or from banks or building societies. These accounts are guaranteed to beat inflation by a small margin, even after tax.

I should qualify that: they're only guaranteed if the financial institution doesn't fail and the government doesn't bail you out. Don't keep too much money in one institution.

Watch out for:

• Not truly inflation-beating accounts. A lot of customers and my colleagues in the industry have been drawn to higher bonuses in some accounts, when the actual inflation-matching part doesn't truly guarantee to match inflation, often due to taxes.

What more can you really ask of, or expect from, your savings, except to keep up with inflation? Getting inflation is a fantastic rate of return for money in a cash account.

Exceptions

Other accounts are occasionally better, but it should be fairly logical.

To give you an example, sometimes we're offered incredibly high interest rates in regular savings accounts. By transferring money out of your easy-access savings every month into these accounts, or paying into them from your spare income, you can expect to boost your savings interest. Once the deal expires, you'll need to find a new easy access home for those savings. For a guide to these regular saver accounts, read Earn 8% on your spare cash.

Another example is that you might not want to lose this year's ISA allowance, so you put your money into one even though there are superior deals elsewhere. You can always transfer your savings to another ISA when a better deal turns up. One matching inflation perhaps.

Savings accounts that will grow your money

The right savings accounts can be a great way to preserve your wealth, but you might want to grow your wealth. To do that you'll need to invest some money in something with more risk than an inflation-linked savings account. I don't mean by guessing what other savings accounts will pay. Those are certainly higher risk to your wealth, but, as I've shown, they don't come with much hope of higher rewards.

For one way of getting better returns, read Savers: Earn 11% on your money!

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