Saving or investing - Which is best for long-term savings?

The economic background

After 13 years of UK interest rates sitting below 1%, there’s been a rapid succession of rate rises, with the Bank of England’s1 base rate currently standing at 5.25% (as at September 2023). And some economists have predicted that there could be one or two further rises before peaking.

The main reason for the rises has been high inflation. The Bank of England is responsible for controlling inflation and keeping it below its target level of 2%. And the main way it does this is by increasing interest rates, the idea being that this will dampen demand and stop people spending so much. Although inflation has now fallen to 6.7% from its peak of 11.1% in October 2022, it remains well above the Bank of England’s target, which is why one or two further rate rises could be on the cards.

The impact of inflation on cash savings

Saving money rather than investing it can seem like a more attractive option as you get a guaranteed return and your money is generally secure in a bank or building society. Investing always includes some degree of risk, even if you choose lower-risk investments. The value of all investments can go down as well as up, and you could get back less than you paid in.

But what you need to factor in, which a lot of people don’t, is the impact of inflation on cash savings. If the rate of inflation is higher than the interest rate you’re getting then you’re essentially losing money in real terms. So it isn’t a completely risk-free option.

Here’s an example:

• In January, you put £1,000 into a savings account, with an interest rate of 5% a year.
• At the end of the year, your £1,000 has grown to £1,050.
• But as inflation has been running at 8% throughout that year, your money has actually lost 3% of its value in real terms. This means that the £1,050 will be able to buy you less now than the £1,000 did at the start of the year.

To grow the value of your money in real terms, you need to put it where returns have the potential to be higher than inflation. And although past performance isn’t a guide to future performance, and the value of all investments can go down as well as up and you could get back less than you paid in, history has shown that investments will generally provide above-inflation returns over the long term.

This chart showing the returns of the main types of investments – stocks and shares (equities), commodities, property, bonds and cash-type investments - against inflation illustrates this.