How I hedge a significant Brexit risk with boring savings accounts

There is a lot of advice on the importance of saving. Saving is critical because it allows you to invest. However, not all savings will go towards investments. Sometimes, you need savings to sit in a cash account to build a deposit or set up an Emergency Fund.

Little advice is however given on how to save. Sure, you could open a savings account, set up a direct debit from your checking account and check rates from time to time to ensure that you have the best deal. Being that proactive alone is probably more than what most people even bother to do when it comes to their financial affairs.

But it is hardly enough.

Saving does not necessarily have to be boring. Yes, it won’t make you rich, at least not in the current low-yielding rate environment. Your savings might even be worth less over time because the rate of inflation in the past few months has been higher than the interest rate of your savings account. If inflation is at 3% and the interest rate of your savings account is at 1.5%, which is quite high at the moment, then you are losing money.

I found this situation to be depressing. Yet, am I supposed to feel powerless, do nothing and watch my savings remain in a state of limbo? Absolutely not.

Savings Accounts with Tax Incentives Should Never Be Ignored

First, you should always take advantage of savings accounts that offer tax relief. This even holds true if such savings accounts have a poor interest-rate or fail to fit a larger savings strategy (such as diversifying currencies). There really aren’t any exceptions to this rule.

Second, I want you to save but I mostly want you to grow your net worth with additional streams of passive income. If you are a high earner, that 45% marginal income tax rate will really bite. You might think that there is a long way to go and that you may never earn that much money. Therefore, you would not have to worry about optimizing your savings from a tax perspective. You are wrong. First, the income tax basic rate is still a hefty 20%. Second, if you multiply income streams as you should, you will realize that making £150,000 is absolutely achievable. Should rates increase one day, you will sorely regret not using your ISA allowance for each tax year.

Taking advantage of savings accounts that offer tax relief is an easy way to save money. As a bonus, it actually requires very little effort – a couple of hours of reading at worst.

Let me hammer home this point: regardless of the purpose of your savings, the currency of your savings or the amount that you are saving, you should direct all cash savings to an ISA up to the full £20,000 allowances. Then only, you can start tinkering with additional accounts like me.

Prior to opening additional accounts, you should make sure that you follow a few good savings habits.

 

Building good saving habits

There is a lot more to saving than just wiring funds into an account. Here are three key points everybody should be aware of:

 

• Hide the balance of your saving accounts: I found that I am more disciplined at saving when I don’t see the balance of the account on a regular basis. As a result, I have accounts that don’t show up on my banking app when I log in online. Not seeing the balance prevents you from thinking that you have money available. You also avoid falling into complacency and thinking that you are doing well. As a matter of fact, you might actually be doing well but you do not want to have that permanent state of mind because it will be a lot harder to continue saving, hustling and investing.

 

• Direct debit is not a bad idea for most people: Another idea that is commonly mentioned is to set up direct debits on payday and forget about the cash until the following month. The obvious advantage is that the process is entirely automated. The excuse of forgetting to set aside cash is no longer valid (assuming it ever was). Personally, I like to make the transfers I need to make every month. I am therefore able to see the progress I am making for five brief minutes and then I forget about it. Also, sometimes you might have to tweak the amounts or redeploy some funds. You can do this at any time but this is when I decide to make the updates I deem necessary.

 

• Split your savings amongst multiple financial institutions: the Financial Services Compensation Scheme (FSCS) is the UK’s statutory deposit insurance compensation scheme for customers of authorized financial services firms. The current limit is now £85,000 per authorized firm. If a financial institution covered by the scheme goes bankrupt, the FSCS will pay you compensation up to £85,000. The limit for jointly held accounts is £170,000. As a result, ideally, you should never have more than £85,000 with any financial institution. The risk is remote as banks have significantly cleaned up their balance sheets but a Northern Rock repeat could always occur. It is not that difficult to open a bank account so there is no excuse: spread your savings between multiple financial institutions covered by the scheme. I have followed that approach, which is also useful to remain in stealth mode. A single account with a balance of £250,000 tends to attract a lot of attention. Bank managers are more likely to reach out to sell you various products and investment plans. One final word: several banks may form part of the same banking group, which will only be covered once by the scheme. In other words, accounts held in banks or building societies that operate under a shared FCA license will only be covered once by the scheme. For instance, HSBC and First Direct share their license: your savings will not be guaranteed separately by each bank.  The £85,000 limit will apply to the combined balance of all accounts held by the two banks.

 

These three steps can be applied by anyone residing in the United Kingdom. There really isn’t a reason why you shouldn’t follow those tips. They won’t make you rich overnight but they are good habits and will protect you against the bankruptcy of a financial institution.

If you have fully used your ISA allowance and are practicing good saving habits, then you can turn your attention to something more elaborate.

 

The pound could plunge in the absence of a smooth Brexit

It is widely accepted that the pound reacts negatively when the headlines focus on a hard Brexit. The prospect of a disorderly exit from the European Union is negatively priced by market participants. When it comes to the currency, this means that traders sell the pound to purchase other “safer” currencies such as the Euro or the U.S. dollar.

If you don’t believe me, just look at how the pound reacted when the results from the referendum were announced:

On the other hand, when a preliminary deal to exit the EU was announced in January 2018, the pound jumped.

The reality is that nobody knows what is going to happen. There might or might not be a deal. The pound will remain volatile until the outcome becomes clearer. And when it does, the pound could either jump or crash. If you have a strong view of what will happen, then enter into a position in your Yolo account. Otherwise, it is best to protect your money from significant currency fluctuations.

 

How to hedge Brexit currency risks with boring savings accounts?

I decided to use my savings accounts to hedge one of the major Brexit-related risks: a sudden plunge of the pound sterling against currencies from other developed countries.

As of this post, I currently have 5 savings accounts. Each has a precise purpose:

 

• Virgin Cash ISA Account: this is my basic cash ISA account denominated in pounds sterling. Each tax year, I use the maximum £20,000 allowance for tax-free interest.

 

• HSBC Premier Savings Account: this is a savings account denominated in pounds sterling for short-term needs. This is the account used to set aside expected expenses such as rent and utility bills. Setting aside those amounts early means that I never have to worry about the balance of my checking account. I think of this account as a revolving facility. If you are extremely disciplined, you could use the credit card as the revolving facility and then immediately repay the card with the funds of this account to take advantage of the points and credit card rewards.

 

• HSBC Online Bonus Account: this is another savings account denominated in pounds sterling for medium to long-term needs. This is the account that could serve me as an Emergency Fund although it is not specifically earmarked for such a purpose. The rate is pitiful but it has the merit to be immediately deployable.

 

• HSBC France Savings Account: this account is denominated in Euros. I also have a checking account that I use when traveling to France. The account is the French equivalent of our ISA so I do not have to pay taxes on interest or file tax returns.

 

• HSBC U.S. Savings Account: this is a savings account denominated in U.S. dollars. I always retain a significant amount there. The interest rate is insulting so I am thinking of redeploying those funds soon in another cash savings account.

 

 

Why do I keep such a large amount of U.S. dollars?

In my previous employment, my salary was denominated in U.S. dollars. It was quite easy to wire a portion of the funds to the U.S. and the rest to the U.K. (paying income tax on the entire amount in the U.K.). I also went to law school in the U.S. so you could say that my access to U.S. financial institutions is greater than for most people living in the U.K. (which is debatable those days with the large choice of accounts offered to everyone).

Now, those funds denominated in U.S. dollars are my primary Brexit hedge. I favor the U.S. dollar over the Euro for a few reasons:

1. the Euro is an imperfect hedge against Brexit as the European Union is party to the negotiations;
2. the Euro is also subject to the whims of Italy and certain other countries. The recent Italian budget has, for instance, caused the Euro to plummet due to its (unambitious) deficit targets and looming confrontation with the European Commission; and
3. the U.S. economy is booming and further rate increases from the Federal Reserve will support the dollar. It is also nice to have U.S. dollars if the currencies of emerging countries such as Argentina and Turkey continue to depreciate. Finally, this is more speculative: each time there are trade spats with China, the U.S. dollar seems to resist better.

One final note on the U.S. dollar: the current deficit of the U.S. government is unsustainable. At some point, reality will kick in and the currency may depreciate significantly. I, therefore, expect this strategy to be revisited in a year or so.

By then, hopefully, we will have a clearer picture of the outcome of the Brexit negotiations. Saving cash is more than a simple wire transfer. Start there but make sure you take advantage of your ISA allowance and diversify your savings with multiple banks if you hold more than £85,000. Then, you can start saving in different currencies.