Why saving is a sucker's game

We explain how a `toxic triple' of problems is making savers miserable!

Ever since I got out of debt in the late Nineties, I’ve been a big fan of saving. By this, I mean stashing cash in savings accounts which offer high rates of interest plus easy access to my money.

Our savings habit is slipping

Though I’ve been a committed saver for a dozen years, I find it tough these days to get overly excited about saving. Indeed, it appears that I’m not the only one starting to lose interest in cash saving.

The following table shows the quarterly savings ratio - how much of our take-home pay we save - since the start of 2009:

As you can see, during the depths of the recession last year, the savings ratio more than doubled, rising from 4.2% to 8.5% in just six months. However, as the economy returned to growth in the final quarter of 2009, the savings ratio fell to 7.2% before slipping again to 6.9% in the first three months of 2010.

Of course, when the economy is in a bad way, we Brits tend to save more of our take-home pay. For example, during the recession of the early Nineties, our savings ratio peaked at 11.7% in 1992. At this time, we saved almost one pound in every eight, which is extremely impressive.

A ‘toxic triple’ for savers

Alas, the UK savings ratio has been in a long-term decline since 1992, bottoming out at a mere 2% in 2008 before leaping to 7% in troubled 2009.

Thus, while the recession gave an almighty boost to the savings ratio, I think that this is a temporary effect which won’t last. That’s because savers today face what I call a ‘toxic triple’ of snags that make saving a mug’s game. Here they are:

1) Low interest rates

It’s hard to summon up the enthusiasm to save when interest rates are at rock-bottom levels. On Thursday, the Monetary Policy Committee voted to keep the Bank of England’s base rate at 0.5% a year. This means that the base rate has languished at an all-time low since March 2009.

Of course, with the base rate at its lowest level since the Bank was founded in 1694, savings rates are the lowest they’ve ever been. In fact, even though the base rate hasn’t changed for 18 months, savings rates have been trimmed this year in order to offer better mortgage rates to homebuyers.

Thus, with rates this low, the interest paid by instant-access savings accounts can be 0.5% or less. This comes to £5p for every £1,000 on deposit, which is hardly worth having.

2) Rising taxes

The second problem for savers is that the UK is running a huge budget deficit. Indeed, for every £4 that HM Treasury collects in taxes and other income, it spends more than £5. Therefore, in order to cut this shortfall, the coalition is cutting public-sector spending and raising taxes.

Although rates of income tax are largely unchanged for most people, a 50% tax rate was introduced in April so as to collect more tax from those earning £150,000+ a year. This tax rate also applies to savings income, so the rich now lose up to half of their interest to the taxman.

Nevertheless, given the sheer scale of government over-spending (estimated net borrowing of around £149 billion in 2010/11), I suspect that more tax rises lie ahead.

Therefore, my advice to all taxpayers is to become a legal tax-dodger by saving inside a tax-free cash ISA. You can shelter up to £5,100 in cash inside an ISA and pay no tax whatsoever on the interest it earns. What’s more, you have until 5 April 2011 to open this year’s ISA - but do it sooner, rather than later.

3) Higher inflation

Finally, perhaps the biggest problem for savers is inflation: the rising cost of living. For instance, if prices rise by, say, 4% over the next 12 months, then your money has to grow by at least 4% after tax in order to keep the same buying power.

Now for some really bad news: the widely used Retail Prices Index (RPI) measure of inflation stood at 5% in June. In other words, the cost of living rose by 5% in the 12 months to June 2010. Sadly, this level of growth cannot be matched by any mainstream savings accounts on offer today.

In short, high inflation is eating away at the value of our savings, and there’s practically nothing we can do about it. Ouch!

On the other hand...

In my opinion, this toxic triple of low interest rates, rising taxes and higher inflation will kill the savings habits of many Brits.

Then again, I’m not going to stop saving just yet. The reason for this is simple: cash is king when times are tough. Indeed, when other asset prices are diving - those of shares, bonds and property - cash trundles on, producing a positive (if low) return, year after year after year.

Thanks to its lack of correlation with other assets, I will keep adding to my cash savings, at least for the near future. When the future is uncertain, there’s nothing quite like cash to get you over the bumps in the road!

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