Evelyn Partners’ Chief Financial Planning Officer Emma Sterland looks at the near-cash or cash-equivalent options for individuals and families looking for cash-alternatives with decent returns – including the firm’s bespoke ‘Cash and Cautious Bond’ strategy.
Evelyn Partners’ Chief Financial Planning Officer Emma Sterland looks at the near-cash or cash-equivalent options for individuals and families looking for cash-alternatives with decent returns – including the firm’s bespoke ‘Cash and Cautious Bond’ strategy.
The Bank of England cut the bank rate from 4.25 per cent to 4.00 per cent today as the monetary policy committee judged, in a split decision, that economic slowdown is currently a greater threat than inflation.
Emma Sterland, chief financial planning officer at wealth management firm Evelyn Partners, says: ‘This probably signals the end of the road for many savings accounts that currently beat inflation, running at 3.6% in June. We can expect to see savings rates reduced in the coming days and weeks, leaving returns on even the best accounts only marginally positive in real terms - especially after tax.
‘That can leave families who want to hold cash in a real quandary.’
The UK has a reputation for having a cash savings culture. It is estimated that cash accounts make up 30% of household assets in the UK, double that in the US where investing is more widespread.[1]
Emma says: ‘While everyone should have a cash buffer in a deposit account, some individuals will find themselves wanting to hold more significant cash savings for a period of time for a variety of reasons.
‘These can include the proceeds of a property or business sale, an inheritance or other windfall, or taking tax-free cash from their pension. Others may be choosing to keep large amounts in cash at the moment, as they sit on the investing sidelines given geopolitical uncertainties and recent market volatility.’
At 12 per cent, the savings ratio in the UK is well above pre- and post-pandemic levels, having leapt to an exceptional one-off peak during Covid restrictions. The FCA reported recently that much of this is being held in cash.[2] Some 61% of people with more than £10,000 in investible assets held at least three-quarters of these assets in cash, rather than investments.[3]
Cautious UK households have been in esteemed company, with Warren Buffett’s Berkshire Hathaway holding an enormous $347bn in cash or cash-equivalent reserves at the end of this year’s first quarter – more than double the amount at the end of 2023 and well over its $264bn of listed equities.
Emma says: ‘Some private individuals and families want the dust to settle on global political and economic uncertainty before committing more capital to riskier assets. Many more have personal reasons why they might want to keep a large lump sum in cash or a cash-equivalent liquid safe-haven.
‘They could have just received a substantial inheritance, sold a property or a business and need a home for their funds while they decide what to do with it. They could be holding lump sums in preparation for a property purchase planned for the medium term.
‘Others approaching retirement, meanwhile, might want to convert a portion of their pension investments to a cash-equivalent portfolio that will protect against any sudden market volatility as they come to access their pot. Still more could have just released their 25% tax-free cash and don’t want it sitting idle while they decide how to use it.
‘Older savers who have funds they want to gift to younger relatives – perhaps over a period of time - will want to make sure the assets earmarked don’t suddenly lose value before they start making the gifts.’
Inflation and tax can make cash savings ‘risky’
While institutional investors like Berkshire Hathaway use a sophisticated range of cash-equivalent assets and securities to sustain the real value of their reserves, the UK’s savers face some headwinds in the form of reduced returns as interest rates come down, inflation remains sticky, and tax on interest poses an increasing threat.
Emma continues: ‘Until recently the environment for cash looked pretty inviting. The benchmark UK interest rate hit a 15-and-a-half-year high of 5.25 per cent in August 2023, and remains elevated in post-financial crisis terms at 4.00 per cent.
'But while higher interest rates have made cash deposits look relatively attractive compared to the rates available since the global financial crisis unfurled, they have been coming down, and after accounting for inflation, real returns are pretty meagre. If a savings account pays the current bank rate of 4.00%, then given the latest annual CPI inflation reading of 3.6%, the real interest rate is just 0.40% - and that doesn’t include the impact of any tax.
‘Of course, inflation eats into all returns whether from investments or cash, but when the real return on cash is so low and with the possibility of further rate cuts, it becomes more urgent to seek better – and more tax efficient - returns elsewhere.
‘We are used to talking about the risk attached to volatile assets like equities, but there is for many people a lot of risk around holding too much cash – the risk of losing money in real terms. And, while all households need a good safety buffer in a cash savings account, there are further headwinds that can make it unwise to hold too much, even in the medium term.
‘One is that with the personal savings allowance – the amount of tax-free interest that can be received annually - frozen at £1,000 for basic rate taxpayers and £500 for those on the higher rate, and its non-existence for the ballooning numbers of additional rate taxpayers, those with large cash deposits could face high tax rates on their savings income. This will erode real returns to negligible net levels in some cases.
‘Those threatened by tax on their savings interest might look towards cash ISAs for protection if they are not already using their allowance for investments, but that’s only £20,000 per person per year – and even that could be in jeopardy, as the Chancellor has been dropping hints that she may look to limit cash holdings in a review of ISAs.
‘Finally, with the Financial Services Compensation Scheme (FSCS) guarantee limited to balances of up to £85,000 per person for each institution, those with large lump sums must juggle a sometimes-unwieldy number of accounts to try and ensure that their money is not exposed to the risk of a bank going under.’
So what are the near-cash or cash-equivalent alternatives that individuals and families can look at as a liquid safe haven? Here Emma Sterland looks at the options.
The DIY options
Savings accounts
‘Some investors may be quite happy keeping their cash reserve simply in bank or building society deposit accounts, shopping around for the best deal or using a cash management platform. Key considerations are whether to opt for a fixed savings rate, notice account or whether instant access is important, and also whether the rate on the account is variable, or includes a time limited bonus. How often interest is paid will also affect compound returns.
‘Moreover, do you hold cash in a standard savings account where interest could be subject to tax or do you use up your annual £20,000 ISA allowance? If the former, are you confident in calculating each year’s exposure to tax and happy with the post-tax return?
‘In order to eliminate the risk of defaults by the savings provider, no more than £85,000 should be held by each person with each institution – but how do you manage and monitor many different accounts where the rates could be changing all the time?
‘National Savings & Investments guarantees 100% of customer holdings, however, so this can be an attractive option to those looking to shelter large sums. While interest on their deposit accounts will be taxable beyond the PSA, the one exception is Premium Bond prizes, which are free of tax. You can hold a maximum £50,000 in Premium Bonds and the average prize rate roughly follows the savings market but is usually lower than the better savings accounts.’
Money market funds
‘Money market funds invest in highly liquid and low risk short-term debt instruments that pay interest such as T-bills, Floating Rate Notes, Certificates of Deposit and government and commercial bonds that are close to maturity.
‘A money market fund will, however, be a one-size-fits-all solution, and returns will be eroded by both fund and platform costs, as well as potentially taxation, depending on where it is held.’
Direct gilt purchases
‘This is an option that only sophisticated DIY investors will have the appetite for, which is why we recommend advice in this area (see below). While interest rates are edging down, bond yields are high compared to where they have been since the 2008 financial crisis, and so more investors are turning to gilts – particularly those set to mature in the next few year years - as an alternative to cash savings.
‘Gilts that were issued during the era of ultra-low rates have very low coupons (the fixed rate of interest they pay), but the prices they can currently be purchased at on the market are below the nominal value they will be redeemed at. This means much of the returns that will be made for those buying now will come in the form of a capital gain, rather than interest payout. From a tax perspective this is very attractive, because for UK private investors gains made on gilts are exempt from capital gains tax.
‘While it is easy to get swayed by the headline yield to maturity available on a particular gilt, and therefore assume the higher, the better, what investors really must focus on where these are to be held outside of tax-free ISAs and pensions, is the net-of-tax yield they will receive. A gilt with a low interest coupon, but where a high proportion of the yield to maturity will come from a tax-exempt capital gain, could be much more attractive after tax, than one with a seemingly higher total yield but where most of this will be exposed to tax on the coupon.
‘So, while gilts can be an attractive option for people looking for a safe home for larger cash balances that they don’t need instant access to, when attractive yields can be “locked in” in an era of reducing savings rates - it really isn’t straightforward and certainly not as easy as picking the ones with the highest headline yields. What really matters is the post tax yield to maturity and that involves calculating the different impact of tax on interest coupons and tax-exempt price gains between now and when the gilt matures.
‘Those who want to gradually access their funds over time by selling gilts can put a “gilt ladder” in place, holding a selection of gilts with different maturities. This is something a good wealth manager will do for a client. However, there are even more sophisticated and flexible solutions available.’
Discretionary portfolios
Emma says: ‘We feel that this is where a good wealth manager can really come into their own as financial planners can work with investment managers to construct a bespoke portfolio that suits individual needs.
‘That could be a “gilt ladder” which works for some clients who want graduated and predictable access to their funds. Or it could be something a bit more sophisticated, combining a gilt ladder with low-risk, short-dated bonds from other high-quality issuers and near-cash instruments, all of which aim to offer higher and potentially more tax-efficient returns than cash and can be accessed as funds are needed. Although obviously, the client is taking on some investment risk with such portfolios that they would not be doing with cash accounts.
‘Our Cash and Cautious Bond[4] is a sophisticated strategy in this respect and many clients are finding it an invaluable option for parking large cash reserves at the moment. It would be all-but impossible for a non-professional investor to replicate the advantages of a strategy like this, which is tailored to individual needs and monitored by an investment manager.
‘The Cash and Cautious strategy blends a selection of high-quality, liquid and low risk cash alternatives, including money market funds, UK Treasury-bills, short-dated Gilts and supranational, sub-sovereign and agency bonds. Bespoke portfolios are created for each client to suit their particular needs, such as duration and how and when they want to be able access their funds.
‘It means that clients have peace of mind that their cash reserves are both working hard for them and are in safe hands.’
See NOTE 4 below for key features of the Cash and Cautious Bond strategy.
NOTES
[1] Bloomberg
[4] Key features of the Cash and Cautious Bond service:
ENDS
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