How do savers find a home for their money and get returns on deposits?

On one level it doesn’t make sense. Returns on deposits are now trending to zero but money is continuing to flow into deposits at record rates.

In fact, many banks are now offering zero returns on deposits yet figures from the Central Bank show households placed almost €11 billion on deposit in the first nine months of the year, pushing overall savings up to a record high of €121 billion.

The pandemic is partly to blame but, as the table shows, our path to becoming a nation of savers started some time ago. It has just been accelerated by the pandemic. This means that we now have the highest saving rate in Europe.

While the savings rate across Europe rocketed to a record high of 24.6 per cent in the second quarter of 2020 – up from a typical level of about 12-13 per cent – the Irish rate stood at 28 per cent of disposable income.

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Saving for a rainy day is no bad thing. The question is where to put those savings.

Restrictions on deposits

The challenge is to find a home for your money while also getting a return on it. Already we’re seeing problems with the first step as financial institutions put a limit on how much money they will accept from you because, in many cases, holding it is costing them money.

This is because banks have been charged for their deposits with the European Central Bank since 2014 and are only now starting to pass on the impact of this to customers. "Savers have really been shielded," says Gary Connolly, investment director with stockbroker Davy.

However, this is changing. EBS will impose a limit of €500,000 in its general savings account later this month, while credit unions across the country have imposed limits typically ranging from €10,000 to €50,000. Most recently, St Ailbe's Credit Union in Co Limerick imposed a limit of €20,000. And new entrants such as N26 have started imposing negative rates.

Connolly suggests this might be only the tip of the iceberg with rising restrictions – and even negative rates – for retail savers now “inevitable”. “Everybody’s in scope at this stage. Rates aren’t going to go positive,” he says, noting that while going from zero to negative 0.5 might not be a great leap in terms of the charges that would apply to an account, it could still sting.

“Psychologically there would be a lot of ill feeling about paying a bank to hold your money,” he says.

And we might already be feeling the pain of negative rates. As Marc Westlake, managing director of Global Wealth, sees it, retail banks have not yet been charging negative rates "explicitly". But of course customers can still be hit in other ways such as bank fees.

“A bank is not a charity, it will find ways to recoup its costs,” he says. “Banks are brilliant at presenting things like it doesn’t feel like it hurts, so we don’t notice it.”

Cost of cash

Leaving too much money on deposit will start to cost you over time. An investment of €1 million in 2020 could fall by €26,408 to €973,592 over the following 10 years, says Connolly, due to the impact of inflation picking up and negative interest rates.

There is also the opportunity cost of not seeking out a better return on your money. According to Connolly, if this money was invested, returning 4 per cent gross a year, it would grow to almost €150,000 by 2030 – a difference of some 52 per cent.

There will always be a requirement to hold some amount of money on deposit, in which case you have to grin and bear the negative rate

While it is purely illustrative and is dependent on certain factors – for example, inflation picking up and returns meeting the target over the period – it clearly shows that cash has now become a risky asset.

But inflation is negative, too, right?

For many savers, the consolation to record-low returns is the fact that inflation, too, is almost non-existent. According to figures from the Central Statistics Office, prices fell by 1.2 per cent in the year to September.

But it’s not as simple as that. “People think inflation is negative so I don’t need to worry about it,” says Westlake. But he warns that historical data shows us that it is “ever present” and is always likely to rebound. “If you look at it month to month, it doesn’t feel like you’re losing money. But that’s a statistical certainty – you are losing money.”

Moreover, while the headline level may be in the red, when you dig down into what you actually spend your money on, you might find your household is facing inflationary pressures.

Education, healthcare, leisure activities – “All of those things have been rising at a lot faster rate than the headline level would suggest,” Connolly says. “The headline level is giving you a false sense that it isn’t a problem.”

Taking action

Given the threats on the horizon, what can savers do? The answer, unsurprisingly given the scale of the challenge, is not a simple one. It likely comes down to holding in cash only what you actually need.

“There will always be a requirement to hold some amount of money on deposit, in which case you have to grin and bear the negative rate,” says Connolly. The challenge is working out how much this should be.

“My experience is people hold and companies hold cash that’s excess to requirements,” he says. “People hold cash at levels that are way too high in terms of a financial plan.”

Westlake agrees: “If you have €1 million in cash, we need to have a conversation about it.”

Alternatives to deposits

Once savers have identified exactly how much they need to keep on deposit for their rainy-day fund or short-term liquidity purposes, they can find a home for it.

Westlake has a solution for this – post-office savings. “That’s the answer,” he says, noting the returns available, ranging from 0.33 per cent annual equivalent rate (AER) on the State savings three-year bond to 1.5 per cent AER on the 10-year solidarity bond.

While savers are often concerned about locking their money away for such terms, Westlake says it often doesn’t matter. “It’s a mistake most people make. They say: ‘That’s a five-year savings term but I need to buy a house in three years, so I won’t put it in’.”

However, the only restriction to getting your money out of a State savings product early is that you have to give seven days’ notice. “There is no break fee,” Westlake says.

Exiting early might affect overall returns but you’re still likely to have done better than leaving it in an account earning zero per cent.

This is not true, however, of a typical bank account, as our table shows. So tread carefully when locking money away outside of State savings.

Another benefit, if you have such a figure in savings, is that you don’t have to worry about the €100,000 guarantee on your savings. With State savings, all your money is guaranteed by the State and most products allow you to allocate up to €250,000 per couple.

Post offices might start to decline, too, so savers should move now to lock into the better rates.

Other possibilities include money-market funds. “These are actually less risky than deposits because they spread the credit risk,” says Connolly, noting that with 30 or so different banks in a typical money-market fund, it is less risky than a single deposit. However, don’t expect a decent return. In the year to July 31st, for example, Irish Life’s global cash fund was down by 1.15 per cent while the global benchmark was down 0.51 per cent.

Another suggestion from Connolly is a covered bond fund. These are lower risk than other products because the underlying assets stay on the balance sheet of the issuing bank, which helps reduce risk. So even if the bank goes bust, the investment should be safe. You could expect a yield of about 1 per cent with such a fund but there will be charges.

Taking on risk

Once you have identified just how much you need in cash, it frees you up to take on a little more risk with the rest of your money. And the key here is looking for a medium- to long-term outlook.

With an outlook of five years and beyond “the risk ceases to be short-term volatility,” says Connolly. Rather, it’s about preserving and protecting purchasing power over time.