Manage Your Cash - Spread Your Risk
The current environment where interest rates are falling and banks are failing gives rise to two key questions.
• How secure are my savings?
• How can I earn more from cash deposits?
Since the recent Northern Rock situation, we have been approached by a number of clients that presently retain substantial funds on deposit, be they personal savings or retained profits within their company. Their primary fear is the likelihood of a repeat situation. This is probably remote, although as Northern Rock has proved, nothing is impossible.
The Financial Services Compensation Scheme (FSCS) provides some security. Indeed, following the above, the Government sought to improve the scheme for deposit holders. Where this previously provided protection of £31,700 (100% of the first £2,000 + 90% of the next £33,000), this now protects 100% of the first £35,000 for each account holder. Therefore, a joint account is protected up to £70,000.
For cash deposit investors holding high levels of monies on deposit, consideration could be given to diversifying across a number of accounts with different providers (not the same institution) to ensure a higher level of protection of their overall balance. However, doing so has it's drawbacks. Administratively, this could become quite cumbersome. Additional paperwork aside, retaining lower levels of funds in an account can have a detrimental effect with regard to the interest rate being received, as interest rates are often tiered, encouraging bigger balances with higher rates. Therefore, in order to enjoy peace of mind, there could be an opportunity cost in the form of lower interest received.
Furthermore, the ‘credit crunch’ could also have an impact on interest rates as banks & building societies seek to increase margins to ‘shore up the defences’. So what is a solution?
Rather than invest specifically into a bank or building society account, why not consider an alternative cash based unit trust. This can provide a number of distinct advantages:-
• The protection provided by the FSCS will increase to £48,000 per person (100% of the first £30,000 + £90% of the next £20,000).
• A wide degree of diversification can be attained via just a single investment, thereby diluting the ‘exposure’ currently experienced with one account provider. An investment of this type can invest with in excess of 100 different institutions.
• Enjoy a higher return. Because the monies are being invested at an institutional level, there is less exposure to tiered interest rates through reducing balances. Indeed, such funds can often provide higher returns regardless of the balance because of the fund manager's buying power.
• Enjoy near liquidity rather than be subject to a fixed period through notice accounts or term deposits.
• Returns may be improved by investing via a variety of different investment / tax wrappers. Clearly the tax position of the individual or company investing should be considered, but this can often be utilised to improve the net return.
Caution should be adopted as some funds marketed as ‘cash’ may include other asset classes, including Government & corporate bonds and asset backed securities. Clearly this elevates the investment risk above that of cash investments alone.
For further information, please contact our Financial Services Partner, Steve Prosser
Date of Article: 1st May 2008
