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But what do you do with money that you are not happy to tie up for such a long period of time? What do you do with that £20,000 that you have scrimped and saved as a deposit for a house? What do you do with that £5,000 that you have saved up to buy your dream car? What do you do with that £10,000 that you have waiting to invest in shares just as soon as you have found that perfect company in which you are happy to invest for the long term? You shove it into a bank account while you wait for the opportunity to spend it.
Which bank account?
Not so long ago the answer would have been to have three different bank accounts. The first would have been your current account, in which you kept enough money to pay all those regular bills, the mortgage or rent, council tax, the electricity and gas bills, and so on. Your current account would pay very little or no interest on any money that you had sitting there.
You would then have an instant savings account, into which you would deposit the money that you did not need immediately, but which you just might need to get a hold of with no notice: for example the money you are holding waiting to buy that dream car, or the money waiting to invest in the stock market. This account would pay you a higher rate of interest than a current account, but for the privilege of being able to get hold of your cash instantly you would be willing to sacrifice a few percentage points.
And finally you would need a high interest savings account, into which you would put the money that you knew you would not need immediately -- this might be the money that you are saving as a house deposit. To get the highest rate of interest you would have to tie up your money for a period, usually 60 days or 90. If you needed the money earlier and could not give the required notice period you would then have to pay a penalty.
This structure of savings accounts made sense; the longer you were happy to tie your money up for the higher the rate of interest that you would get. This structure of tiered interest rates is still in force in most of our high street banks; for example if you pop into you local Lloyds TSB (LSE: LLOY) you will find the following rates of interest paid:
• On the "Classic" current account you get 0.1% (AER* see bottom of article) interest gross per annum (yes -- just 0.1%!).
• If you put £5,000 into an "Instant Gold Savings" account you would get 3.45% AER gross per annum.
• Putting £10,000 into a high-interest 90-day "notice" account gets you 4.05% AER gross per annum.
However, the world of banking is being turned upside down. If you shop around you will find that the best interest rates are now being paid on instant (or near-instant) access accounts operated over the Internet or by telephone. Why tie your money up for 90 days and earn a measly 4.05% when you could get 7% or more and still be able to get hold of your money straight away?
Short term rates are better than long term!
How is it that "short term" savings rates are now higher than long term savings rates? It's all down to competition. New banks have opened up that are using new technology and that don't have the burden of an expensive branch network. These banks are fighting to build their businesses and the way they are doing this is by offering more attractive rates than the competition. Fools should take advantage of this and make sure that they get the very best savings rates on any money that they have tucked away.
The best Internet instant access savings account that I have been able to find currently is with Cahoot (part of Abbey National (LSE: ANL)) who will pay 7.1% (AER) gross on savings of £5,000 or more, in an account operated without a chequebook. Why keep a current account paying you just 0.1% interest (remember this is before tax) when you could open up a current account over the Internet with Cahoot, which will give you all of the services associated with a traditional current account, including a cheque book, and which will pay you 5% (AER) gross as long as you keep a minimum of £1 in the account.
Unfortunately Cahoot will not allow you to open up a two accounts (one with a chequebook paying 5% or more and one without a chequebook paying 7.1% on balances over £5,000). This would have enabled you to switch funds between the two, juggling your money around easily thanks to the web-based nature of the accounts and so maximising the amount of interest that you would earn.
So here is my 4-step guide to maximising the interest that you earn on your savings.
1. Review the rates of interest that you are currently receiving on all your interest-bearing accounts. Check to see if you are carrying too much money in a current account earning next to no interest each month. Resolve to only give your cash to banks and building societies that pay you high interest, with no penalties.
2. Don't use high street branch-based accounts. Banks justify the low rates that they pay on these accounts by claiming that the costs of running over the counter accounts are much higher than those where customers use the phone or Internet. Think hard before you continue to use your traditional branch-based banking services; do you really need to see someone face to face very often? Don't fall in love with your bank; be mercenary and switch to the bank that gives you the best deal.
3. Check best buy tables in national newspapers or on the Internet. Compare the interest rate you are currently being paid to those in the best buy tables. Top paying accounts at present include Nationwide's e-savings account, which offers 7% on deposits of £1 up to a maximum of £50,000. Abbey National's Internet bank Cahoot is offering 7.1% on £5,000 with no maximum deposit.
4. Be prepared to switch banks when necessary, and certainly more often than you have in the past. Most people think that it is just too much effort to switch current or savings accounts and many prefer to remain loyal to their bank. But it is this apathy that enables banks to get away with paying awful interest rates. Switching banks is now much easier than it used to be: you don't even have to worry about setting up all your direct debits and standing orders, the bank will usually do that for you.
And Finally...
Whatever you do, don't let apathy allow you to accept a lower rate of return on your cash than is necessary!
* AER is the Annual Equivalent Rate and is the notional rate which illustrates the tax-free rate as if paid and compounded on an annual basis.
Where Next?
• The Fool's Guide to online banking
• UKInvest best savings rates table
• The Guide to Foolish Home Owning
• The Fool's Guide to Buying a Car