What happens if you take the default deal in any transaction? Usually, you get screwed.
It happens with mortgages: default to the standard variable rate and you’ll pay a good 4% interest at most lenders – at a time when the best remortgaging deals are coming in at well under 2%. You can even get a ten-year fix for not much more than 3% with a little effort and equity.
It happens with insurance: in FT Money last week, Paul Lewis revealed how he saved over £650 on his home insurance by shopping around – with the cheapest quote coming from his existing supplier.
And, you won’t be surprised to hear, it happens with pensions. Hargreaves Lansdown, the biggest of the UK investment platforms, has just produced a report comparing the average returns from default pension funds to the average return from the top ten most popular funds (as measured by the choices of the 19,000 people who have opted out of the default in the HL workplace pension). The results will make nervous reading for those running defaults.
Don’t stick with default funds
The actively made choices outperformed the defaults by an average of 4.08% over the past five years. There’s only a couple of percentage points in it, so stop with the nitpicking, you may say. But this isn’t nitpicking. It matters.
Default funds are supposed to be simple, basic and suitable for everyone. But that’s no reason for them to be systematically awful. And as all mathematically sentient readers will know, one percentage point a year quickly compounds into real money.
Hargreaves assumes that a 22-year-old starts on a salary of £30,000 and saves 8% into their pension until they are 68. They pay charges of 0.75% per year; make a return of 5% and will have £187,000 at the end (in real terms).
Make the return 6% and they’ll have £243,000 – going on 30% more. It may be that your own scheme’s default doesn’t fit into the same deeply disappointing category as most (mine does). But the lesson is simple: never assume the default is going to be the best, or even a good choice.
Cash savings account are the worst
Still, of all the miserable default rip-offs around, cash savings accounts look like the worst. It is not exactly a secret that the UK’s banks operate an apathy model – most people can’t drag up the admin energy to move bank accounts and so the banks can totally get away with paying little to no interest on savings.
You can, at the moment, choose between getting an effective 0% on your instant access savings account or 1.5% (that sounds like not much, of course, but remember the magic of compounding) if you can find a couple of minutes to open an account with Marcus or ICICI Bank.
If we were all on top of this stuff, the 0% accounts wouldn’t exist. You might also note that this is a situation I expect to get worse rather than better for too many of us. The banks are getting the hang of data mining. If you aren’t showing up as a proactive customer who’s likely to move, you probably won’t be able to expect much in the way of interest from them in the future.
There is one thing to be said in the defence of the cash savings industry: part of the actual business model of banks is to arbitrage interest rates – to create as big as possible a gap between what they pay on the money you save and the price they charge for the money they lend. So you can’t completely blame them for the result. This is how capitalism works. If you shop around you get an OK deal. If you don’t, you don’t.
Cash isn’t king in your investment accounts
Where I get a little crosser is the behaviour of the investment platforms towards our cash. Hargreaves Lansdown does more than just make it easy to buy and sell listed assets. The platform also manages an awful lot of cash. And it makes real money from it. Flick through the most recent interim accounts, and you’ll see £33m of revenue from cash. At the moment, that’s 14% of total revenues.
Look at the interest rates on offer at Hargreaves and you will fast see how this works. The best you can get on your Isa is 0.15% and the best you can get in a Sipp is 0.35%. The Bank of England’s base rate, just as a little reminder, is 0.75% and CPI inflation is 2%.
Hargreaves says, absolutely correctly, that its rates are better than those of their competitors (Interactive Investor and The Share Centre pay 0%); that money in Sipps and Isas usually needs to be available for trading immediately and so reflects instant access rates; and that it has a service for actual cash savers – called Active Saving.
This allows clients to move their money around savings accounts at a variety of banks with no extra admin. It is an excellent service. But you can’t get it for cash in a Sipp or an Isa (even if you want to hold the cash long-term). And that matters, too.
Most of us think of cash holdings as part of our asset allocation – something that gives us optionals inside our portfolios. Sure, our aim is to be fully invested the majority of the time. But we also want to hold cash strategically. According to data from financial website Boring Money, the top eight platforms in the UK currently hold a whopping £17bn in cash.
Let your provider know what you think
You might perhaps have been waiting for a sign that the US is getting nervous about monetary tightening before investing. If so, now might be time. You might have been sitting out because of Brexit. Now is also perhaps time to get back in – note the yield on the UK market is now up to 4.5%.
Alternatively, you might believe that we are soon to enter a period of deflation, in which case cash might be the best thing to hold. Or you might just be long-term apathetic. Either way, my point is that cash is a perfectly valid asset class to hold and you are as entitled to receive returns on it as you are to the returns on any of your other assets.
Imagine if your platform was withholding 75% of your dividend payments. You’d be livid. For the moment, I can’t see much choice but for us Sipp and Isa savers to take the hit on our cash when we have it – and to think of this as the price of optionality. But there is one thing you can do: write a note to your provider to hurry them along. Or maybe tweet them about this. They are all always saying how much they love feedback. Give it to them.
• This article was first published in the Financial Times