Investment platforms have a new source of juicy profits, boosting their coffers by hundreds of millions of pounds.
The only problem? This source is the savings interest that they earn on their customers’ money, which the platforms keep for themselves.
Companies such as Hargreaves Lansdown, AJ Bell and Interactive Investor are making record sums by putting their customers’ cash into low-risk savings accounts where it earns handsome interest.
The platforms then pass on this interest to their customers, but without skimming any part of it for themselves.
It was revealed last week that market leader Hargreaves Lansdown made an impressive £268.7m this way last year.
Companies like Hargreaves Lansdown, AJ Bell and Interactive Investor are making record sums of money by taking their customers’ cash and earning tidy sums in interest
How DIY investment platforms make money
What did Hargreaves Lansdown do to earn this huge sum? Nearly nothing.
We spoke to investment analysts to understand exactly what investment platforms need to do to make significant profits on savers’ cash deposits.
Platforms do not reveal their strategy. But analysts tell us they don’t need to make smart investments, invest time and care in finding the best savings accounts, or even do anything to justify such generous financial rewards.
This is because major financial companies such as investment platforms have access to accounts that pay more than 5 percent interest, which is off-limits to ordinary savers.
The interest rate they can earn just by leaving money in the bank overnight is currently around 5.19 percent. This rate, known as the Sterling Overnight Index Average (SONIA), is published every night by the Bank of England.
Financial services analyst Ben Williams explains: “Platforms need to ensure that customers’ savings are easily accessible, as customers have the option to withdraw them at any time.” Therefore, they are likely to simply leave it in such a savings account and pay a good interest rate, instead of investing it.”
Put simply, investment platforms can simply put their customers’ money into a cash deposit, withdraw more than 5 percent of it, and then pass on whatever they give to customers.
How much interest do the main investment platforms pay?
How much they pass on to savers depends on the platform, the amount of cash deposited and the type of account in which it is held.
For example, Hargreaves Lansdown pays 2.75 per cent interest on up to £10,000 held in Stocks and Shares Isas, Junior Isas or Lifetime Isas, but 1.5 per cent on fund and shares accounts.
It pays 3.45 per cent on up to £10,000 held in a Sipp (self-invested personal pension), and higher rates for larger balances.
AJ Bell pays between 1.95 and 2.45 percent on cash in Isas and 3.2 to 3.7 percent on cash in Sipps.
Interactive Investor pays between 1.75 and 3.75 percent on cash in Isas and 2.75 to 4 percent on cash in Sipps.
While some rates are more generous than others, none come close to the 5.18 percent risk-free interest rate that the platforms currently enjoy.
How much do you earn?
Hargreaves Lansdown says that on average the difference between the interest rate it receives from its customers’ savings and the amount it passes on to them is 1.92 percentage points. This is called the net interest margin.
Mr Williams estimates that Hargreaves Lansdown pays an average of 3.1 per cent interest on its customers’ cash.
For example, if you had £10,000 cash in a Hargreaves Lansdown account, you would earn around £502 a year on average.
Hargreaves Lansdown would then give you £310 of this but keep £192 for themselves.
Holly Mackay, managing director of investment website Boring Money, explains that platforms have always made money from their customers’ cash holdings.
“When interest rates were extremely low, this was much less of a problem,” she says. “But now savers can earn 5 percent when they deposit their money into an easily accessible account, while platforms still pay significantly less.” “The imbalance is clearly visible.”
Making money with cash is part of the business model
Hargreaves Lansdown has no intention of reducing its own cut in savers’ rates, even if rates fall.
Hidden in the details of its financial report is that its net interest margin is expected to remain at a generous 1.8 to 2 percentage points next year.
Even if the Bank of England’s key interest rate falls to 3 to 5.25 percent, Hargreaves still wants to extract 1.8 to 2 percentage points from savers’ interest rates.
This means customers’ interest payments will fall – but Hargreaves Lansdown won’t lose out. If the base interest rate falls to 2 to 3 percent, Hargreaves would still be content with 1.5 to 1.9 percentage points of interest on customers’ cash, the report says.
Hargreaves Lansdown says it has passed on 85 per cent of the benefits of base rate increases to its customers over the last 12 months and will “broadly do the same” if further rate rises occur.
How to earn more with your money
While some investment platforms also offer savings platforms, the problem for investors is that this is a separate pot from the money they hold in an investment account provider’s savings platform.
For money held in a general investment account this isn’t such a problem, but if they’re putting money into their Isa or Sipp they can’t just take it out and put it into a cash savings account.
An alternative is to keep cash in a Best Buy savings account and then transfer it to your investment account when you’re ready.
It is also possible to transfer a cash Isa into a stocks and shares Isa, which could help with the Isa allowance.
This option is not available with a Sipp.
> Best savings rates
> Top offers on savings platforms
> Best cash Isas
Why do you need to be careful when moving?
As a general rule of thumb, savers who are dissatisfied with the tariff or service of their existing savings provider should look for a cheaper offer.
However, with investment accounts, withdrawing cash is not as easy. With Junior Isas, Lifetime Isas and Sipps you can only withdraw your money from the age of 18, 60 or 55 respectively.
In the case of Isas and Sipps in general, if you withdraw cash from your account it will lose its tax-free protection and could end up costing you more in the long run.
You can switch your entire investment account to another provider, but it’s rarely worth it because of the cost and time involved just to get a better savings rate.
This means that customers essentially have no alternative but to accept the platforms’ paltry interest rates.
Some may argue that investors should not hold cash in investment accounts; You should leave it invested instead.
However, there will be times – particularly when market uncertainty is high – when investors may want to temporarily hold back some cash and wait before re-entering financial markets.
Additionally, some platforms require customers to have some cash in their accounts so that they can pay the platform fees when they are due.
What can investors do with their money?
Some investment platforms also have savings platform accounts that offer competitive interest rates.
Hargreaves Lansdown, for example, has an easy-access account that pays 4.54 per cent as part of its Active Savings offer.
These accounts tend to be much more lucrative for customers – but less so for platforms. Hargreaves Lansdown earns just 0.14 percentage points on the cash in its Active Savings accounts.
Jeremy Fawcett, head of platform research firm Platforum, says it may become easier to switch between savings and investments within the tax-free shell of an Isa or Sipp: “As banks and platforms increasingly offer both investment services and savings accounts, this should be the case .’It will be possible to save and invest in the same environment in time.’
However, it remains to be seen whether platforms will ever make this possible for customers.
After all, Hargreaves Lansdown has just made a whopping £268m from the interest gap – and has no plans to take a share of this nice little earner. In the meantime, watch out for this hidden drain on your savings.
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