Why your mattress makes a bad bank

With banks collapsing across the world, you might be tempted to keep your cash under your bed. Here are five reasons why this is a big mistake!

This article has already been emailed to readers as part of our 'Afternoon' series.  

On Monday night, at a monthly meeting of investors, I spoke to a Fool reader whom I shall call Chris. During our discussion, Chris warily admitted that he had refrained from investing in shares for nearly two years, preferring instead to keep all of his liquid wealth in cash.

Then again, Chris had nothing to be ashamed of, because his strategy has produced a small positive return, while many stock-market investors have endured large negative returns and substantial losses. Indeed, the FTSE 100 index is down nearly a third (31%) in the past twelve months. Ouch.

Of course, we all know that shares are riskier than cash. However, even cash itself can be risky if it's not properly looked after. This thought came to me after overhearing "I should have kept my money under the mattress." This is a fairly uncommon remark, so I was surprised to hear it several times in recent days.

Five reasons to avoid the 'Mattress Bank'

Given the global meltdown in financial markets, I can understand why some people feel anxious about entrusting their spare cash to banks, building societies and other deposit-taking institutions. After all, the collapse of Northern Rock, Bradford & Bingley and Icesave left savers in terror of losing their nest egg.

Sadly, around 8,500 British savers did indeed lose their life savings when offshore subsidiaries of certain UK banks blew up last year, as I revealed in The Perils Of Saving Offshore. Nevertheless, I would warn against withdrawing money from savings accounts in order to hide it under your bed. Here are five reasons why the 'Mattress Bank' is a bad place to stash your cash:

1.    Your mattress doesn't pay interest

The first (and most obvious) snag with the Mattress Bank is that it doesn't pay interest on any deposits stored. The main attraction of conventional savings accounts (and Best Buy current accounts) is that they pay interest on cash deposits. Alas, the Bank of England has cut its base rate five times since early October, reducing it from 5% to 1% -- an all-time low. Thus, savings interest rates have plunged, making saving a less attractive option than it once was.

2.    Inflation eats away at your money

Under the mattress, your cash earns no interest and, therefore, produces a yearly return of zero. The problem is that inflation (the tendency for the price of goods and services to rise over time) erodes the future value of your money. For example, with yearly inflation of 3%, £100 in a year's time will buy goods costing only £97.09 in today's terms, because £100/1.03 = £97.09. So, it's important for your savings to keep pace with inflation wherever possible, which makes the Mattress Bank an unsuitable haven for your hard-earned.

3.    Banks are more secure than bedrooms

One advantage to banking your money, rather than keeping it in cash, is that banks are hugely more secure than households. Indeed, if your home is broken into and cash is taken, you will find that your home insurance does not cover large sums in cash. Typically, most policies will cover only up to £500 of cash and cash-equivalents held in the home.

Even if you take extra steps to improve your home security, you could still lose out. For example, cash taken from a home security safe will usually be subject to the overall limit mentioned above. On the other hand, if your local bank branch is raided by armed robbers, then you won't lose a penny, as your bank is insured and will cover any loss.

4.    Paper notes are easily damaged

Last April, BBC News Online reported the tragic case of a 65-year-old butter trader in India who had deposited his life savings (450,000 rupees, worth £6,450) in a safety-deposit box at his local bank. Unfortunately, termites infested the bank and feasted on this poor man's paper notes, yet his bank refused to accept responsibility for his loss. Obviously, there are no white ants in the UK, so our banks don't have to worry about note-gobbling termites. However, paper currency is easily destroyed by fire, flood and other hazards, so it pays not to leave too much folding stuff lying around.

The good news is that damaged notes can be exchange for replacement currency. In fact, in 2007, the Bank of England exchanged £40 million of damaged notes. Last summer, a binman in Lincoln found £10,000 of cut-up £10 and £20 notes in two litter bins. By painstakingly piecing these back together, he could pocket a ten-grand prize for completing this financial jigsaw puzzle!

5.    The Mattress Bank is not a member of the FSCS

UK-registered banks are protected by the Financial Services Compensation Scheme (FSCS), a state-run safety-net which protects cash deposits. The FSCS covers the first £50,000 per person per separate institution, as we explained in The Facts About The Savings Guarantee*. Needless to say, the Mattress Bank isn't a member of the FSCS, which is our fifth and final reason to avoid this savings store.

* Unless better protection for foreign banks is available in their home country, see Anglo Irish Bank Now In Safe Hands.

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