Tips | November 7, 2018

More isn’t always what you need: seven questions about your savings answered

The main question on savings is usually “how do I get more?”. We look at seven situations where "more" is not key.

There is a lot of information about savings available on the internet and if you’ve already done some reading before coming to us - our feelings aren’t hurt, we promise - then you’ll have seen that a lot of it is tips on how to start saving, how to save more, how to stick to a budget, etc. The main story is that saving money is good and you should totally do it. But many still don’t and even those who do may not be looking at the full picture. With that in mind, let’s have a look at seven questions that may not have popped into your head yet or that you haven’t been given an answer to so far. These don’t revolve around simply getting more. They’re about what you need.

1. Is saving even worth it if you don’t have much to save?
Have you ever gone to an online savings calculator to see what riches you could gain? And were you shocked that your hard-earned cash would only earn you about £5 of interest in 12 months?

It hardly seems worth it at first glance. But it’s important to note that savings accounts aren’t there to make you rich. They allow you to set aside money in a different place so you don’t spend it and might promise a small reward for doing so.

While that may seem like common sense, it is easy to get bamboozled by clever marketing-speak that makes it sound like you’ll gain a lot of money by saving.

In truth, most of the money in your savings account you put in there yourself. Only a tiny percentage will be “new” money gained from interest.

And because it’s percentage-based, the more money you put in, the more you’ll get as interest. For instance, if you put £25 per month in a savings account at a 3% interest rate, you’ll have roughly £305 after 12 months. £300 of that is money you put in yourself and £5 is your interest.

While £5 isn’t necessarily getting you closer to buying that house you’ve been eyeing, having money in a savings account can help you resist the temptation to spend it. Even if it won’t make you rich.

And the longer you have money in a savings account, the more it will accrue, thanks to compound interest. Simply put, whenever interest is paid out, it’s based on the full amount in the savings account.

So if you get paid £5 interest after the first year based on the £300 you put in, the next year your interest will be based on £305. That way, your interest will start making you more money as well.

For long-term saving goals like retirement, that can really start to add up. For short-term saving goals it may not seem amazing, but maybe that’s because you’re taking your mental accounting too far. More of that in question four.

2. How many savings accounts do I need?
It’s usually a good idea to have a savings account for a specific long-term goal, like retirement or buying a home, because there are savings accounts with better interest rates that are aimed specifically at those goals.

But besides having those one or two special accounts, you’ll want to minimise the number of places you’re storing your money. Let’s say you have a general savings account with no specific goal in mind. If you add more money to that single account for short-term goals, that will increase the interest output of that account.

To give an example: if you have £1000 saved up already but want to aim at an extra £500 for a specific goal, you could add £50 to your savings account each month for 10 months, then take it out but leave the interest you made in the account.

Instead of only getting interest on the original £1000, you’re getting it on the extra £50 per month as well. This boosts your general savings, even if only a little.

3. Where should I go to save?
The simple answer is a bank or other financial institution that offers savings products. But which one is the right one for you?

There are many financial technology institutions, called fintechs, on the rise that often have great apps and are easy to use. However, they don’t always offer the same rates as “classic” banks that have substantial wealth behind them.

So if you’re looking for the best rates possible, don’t dismiss the classics in favour of something new and flashy. If rates aren’t your primary concern, though, do compare what fintechs can offer you.

As time goes on, you’ll probably find that they are getting closer and closer to each other in terms of offerings. The popularity of fintechs is starting to give them the financial backing to compete with traditional banks on rates and products.

Meanwhile, banks are learning from fintechs and implementing technological advancements like robo-advisors, automatic saving, and more user-friendly apps in general.

4. Should I take money out of my savings?
If you have reached your savings goal, yes, you should. Otherwise, why save in the first place?

Seeing money accumulate in your savings account might feel great, but remember the money is in there for a reason.

If you want to take a year off to travel and you’ve been diligently saving up money to do so, then once you’ve reached your goal, you should take that money and travel.

Or if something big like your washing machine suddenly breaks and you need money for repairs or to buy a new one, you shouldn’t feel bad about using your savings. That’s what they’re there for.

Many tend to feel guilty dipping into their savings for various reasons. First, many savings accounts have some form of penalty in place when you take out money. So-called “loyalty” savings, for instance, could have an interest rate of 0.65%, but if you take out money, it drops to 0.55%.

This can play into people’s fear of loss or of missing out, so they’ll leave their money where it is, even if they need it.

Another reason people won’t use their savings is because that money is “earmarked” for a specific goal: they’ve decided it shouldn’t be used for anything else. So if your washing machine breaks, surely you can’t take money out of your travel fund to buy a new one!

Actually, yes you can. People have weird mental quirks, in this case called mental accounting, about what they can and can’t do with their money. But remember that needs, generally speaking, should trump weird mental quirks.

5. Should I go into debt to keep my savings?
Let’s go back to your broken washing machine. If you don’t want to use your savings, should you take out a loan or go into credit card debt instead?

For some, that seems like the way to go and while it may feel good to leave your savings untouched, debt can hurt you much more in the long run.

The main reason is the difference in interest rates. Debt usually has a much higher interest rate than savings, which means that any interest you make saving will be nullified by the interest you have to pay back for your debt.

Still, it’s often thought to be easier to pay off a debt than it is to rebuild savings. It’s another weird mental quirk that isn’t a rational conclusion. If you’re in a situation where you’re not sure whether to use savings or your credit, do a calculation of how much you’ll lose for each option.

6. What is a prize-linked savings account?
There are many different types of savings accounts and it can change from country to country (as well as company to company). Most will still have standard savings accounts, but there are a few interesting options.

One of those options is a prize-linked savings account. Premium Bonds in the UK are an example of this. These bonds don’t have an interest rate; instead, the interest is determined each month via a raffle.

You can enter the raffle simply by buying £1 bonds. Each bond gives you a chance to win, so you’ll have a higher chance of winning if you buy more of them.

If you’re lucky, you can win more than the average interest rate. If you’re extremely lucky, you can win a huge chunk of money. But based on the odds, the vast majority will win absolutely nothing.

So why is it popular? For low-income households, it represents a chance to gain more money than they normally would in their current financial situation. That chance is very low, but people tend to overestimate their odds of winning, just like they do when gambling.

The positive side is that people never lose their initial deposit with prize-linked savings. But if they never win, they also won’t increase their savings.

However, if we go back to question one really quickly, it’s not too hard to see why some, especially those with low incomes, would be tempted to try their luck with a prize-linked savings account.

In question one, we showed that if you save £25 each month for 12 months at a 3% interest rate, you’ll gain about £5. So what if you used that £25 pounds to buy bonds or “raffle tickets” instead? You would have 25 shots at “winning big” each month for 12 months.

If you compare possibly winning several thousand pounds to a certain gain of £5, you can see the appeal of option one.

But as mentioned before, there is an extremely high chance you won’t win anything at all. And there are currently no studies that suggest prize-linked savings accounts are helping people save more.

7. How do I help my children save?
Savings don’t just affect you, they affect your children as well. Studies have found that young adults whose parents have savings accounts are much more likely to have savings accounts or other financial assets themselves.

This likelihood increases when parents saved on behalf of their children when they were growing up. Especially, it seems, if those savings accounts were in the children’s names.

Giving them a bit of control over the account, like setting goals or having them make a deposit themselves, might even help motivate them further.

In addition, if you start saving in your children’s names early enough, even if it’s only a small amount every month, it might cover part of the cost of tertiary education as well as make your child more financially savvy.

Key takeaways:

  1. Saving is always worth it, even if you don’t have a lot (cliché, we know)
  2. You don’t need a bunch of savings accounts; one or two specific accounts and one non-specific savings account will do for most people
  3. Compare savings products from traditional banks as well as fintechs to see who offers you what you need
  4. Your savings have a goal and once that goal is reached, use the money
  5. You can lose more money going into debt rather than using your savings, because interest rates for debt are higher
  6. Savings accounts where your interest is based on whether you win a raffle, more often than not mean you won’t increase your savings at all
  7. Putting savings accounts in your children’s names increases the likelihood that your kids will grow up to have savings for themselves, too
eZonomics team
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