Ian Thomas, Pilot Fiancial Planning
Low Interest Rates: Is There a Solution?
Over the past few months, I’ve spoken to a number of new clients who are all concerned about the same issue; very poor returns on their bank savings. With record low interest rates looking like they’re here for some time to come, this is an increasingly common worry for the many people who are either living off their accumulated wealth or trying to save for the future. So what, if anything, could or should be done?
The main appeal of saving with a bank is that it feels completely secure; the value of your account should never fall (although the recent events in Cyprus remind us that nothing in life is ever 100% certain!). Despite this apparent safety, however, over the longer term bank saving is actually a pretty risky investment for a different reason - inflation.
Of course, there have been times when interest rates have been much higher than now,but these periods have often coincided with bouts of higher inflation. Data going back to 1956 indicates that average building society interest rates (net of basic rate tax) have not kept pace with inflation, lagging it by over 1.5% per annum on average over this entire period.
So, although the problem may be more apparent to us today, the current very low nominal interest rates are really not that unusual in real terms (ie. after inflation). This has some serious implications for longer-term savers, not just now, but in the future too. If you’re aged 60 for example and using your bank interest payments to support your lifestyle, an inflation rate of just 3% per annum will cut your real spending power by almost half by the time you reach 80!
The key question to ask yourself then, is whether you are comfortable to move out of cash-based savings into other forms of investment. By doing so, it’s inevitable that the nominal value of your investment will fall at certain points. For some people, this makes any form of investment a non-starter. In the longer run however, investments linked to ‘real’ assets such as company shares or property are much more likely to maintain or even increase the purchasing power of your money. In short, by moving your money out of the bank you are effectively trading inflation risk (highly dangerous, but almost imperceptible) for investment risk (generally short-term but often very obvious).
Many people expect me to be able to predict which of these different types of asset or even individual shares, are going to perform well and which ones to avoid. Speculation like this makes for interesting news headlines but, unfortunately, the evidence is that it’s unlikely to be a winning strategy. The majority of professionally-managed funds lag the average market return by a significant distance.
Fortunately, the risk of investment losses can to a certain extent be managed, without the need for a functioning crystal ball. Phasing your investment reduces the risk that you buy at a market high but it’s even more important to ensure that your portfolio is thoroughly diversified, both within markets and across different asset classes. The precise mix will depend on your desired return, together with your willingness and capacity to suffer short-term losses.
Being able to manage your emotions is another key ingredient of successful investing. Too many people buy high and sell low, not vice versa! In fact, I’d like to think that the most significant value I bring to my clients, in investment terms, is a more considered and rational approach, helping them to manage both the fear and the greed which can be so damaging to their long-term financial security. •
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
Contact Ian Thomas at Pilot Financial Planning:
08453 712 808, ian@pilotfinancialplanning.co.uk
www.pilotfinancialplanning.co.uk
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
First Published July 2013 By The Dart
