Take advice to make your cash work harder

QARecord low interest rates have led to paltry returns on cash savings and it seems unlikely that we are going to see an improvement any time soon. Where can I find better returns? CASH in the bank is psychologically comforting, easy to access and technically very safe. However, as inflation rises, more and more savings accounts are effectively paying negative real returns. The average cash ISA pays less than one per cent interest, while easy access savings accounts pay less than 0.5 per cent.

Chancellor Philip Hammond has promised a new ‘marketleading’ NS&I Bond that is likely to pay 2.2 per cent. However, even that may not pay enough to deliver a positive real return after inflation. The Office for Budget Responsibility expects the Consumer Prices Index to peak at around 2.6 per cent in the spring of 2018.

Given already low rates and the prospect of significantly higher inflation, investors who have the appropriate risk profile should be looking to make their money work harder than simply sitting in the bank.

Equities have proved to be the best-performing asset class for those who have a long enough time horizon. The income that shares pay, usually via dividends, can also beat that of the best savings accounts – and importantly inflation. The average dividend yield of companies in the FTSE 100 is currently around four per cent.

Before moving into equities, it is vital to discuss your attitude to risk and the level of risk necessary in a portfolio to generate the returns needed. Shares can be volatile and you should be careful not to risk what you cannot afford to lose. There is a risk that with many people chasing dividend yields to beat bank interest that the share price of high income paying shares could be overinflated, heightening the risk of loss.

However, historically investing in the stock market and reinvesting the income has generated higher returns than other assets classes such as cash and bonds. And it is important to remember that, while cash may appear low risk, even low levels of inflation can erode savings over time.