Many of us have been brought up to believe that saving is the responsible thing to do. But in today’s environment of low interest rates and rising inflation, savers may need to consider becoming investors to prevent the erosion of their assets.
Since the global financial crisis of 2007–8, the world’s central banks, including the Bank of England (BoE) have responded by cutting interest rates to record lows. This reduces the cost of borrowing, encouraging spending by consumers and businesses, but it also discourages saving.
The BoE has acknowledged this is a problem. Andy Haldane, its chief economist, said “I sympathise with savers, but jobs come first”. In its efforts to keep Britain’s economic recovery on track, the central bank has prioritised growth over the needs of savers.
That pressure has intensified following the UK’s recent vote to leave the European Union. The pound has fallen heavily against most other major currencies, which means imports have become more expensive. So savers are not only facing lower interest rates, they are also facing higher prices.
Higher inflation and near-zero interest rates mean the responsible thing to do could be to invest rather than to save. The best instant access savings accounts currently offer an interest rate of just 1%*. With the current rate of inflation in the UK already matching that (and heading higher according to BoE forecasts), you could actually be making yourself poorer in real terms by keeping all your money in savings accounts. You might even question whether it is better to splash out on some extravagant purchase instead – a new car or a long foreign holiday perhaps. But when you have your entire lifestyle, family and retirement needs to consider, splashing out on luxuries is unlikely to be the best solution and the joys of doing so may prove short-lived.
So what are the alternatives? Government bonds are often considered to be one of the safer investments after cash, but the prices of government bonds have risen so much in recent years that the income they provide (their yield) is now close to zero – prices and yields move in the opposite direction.
There are plenty of other options to consider, although the search for higher yields will often entail higher risk. That risk, however, needs to be set against the likelihood of inflation eroding your savings in the longer term.
Equities are traditionally regarded as riskier than government bonds. But many of the shares paying the best dividends are often found in areas generating reliable profits. For example, utilities companies usually have reliable income streams, as people still need to switch the lights on and heat their homes. And while the value of shares can fall as well as rise, successful companies can still increase their dividends – in contrast to the fixed income offered by bonds.
We believe the equity markets of the developing world can also offer real attractions. For example, many economies in Asia and Latin America are growing rapidly and contain companies that represent good opportunities for investment.
Then there are corporate bonds, these fall into two categories. Investment grade corporate bonds are reckoned to represent a lower risk of failing to pay investors, or “defaulting”.
Meanwhile, high-yield corporate bonds are more risky, but reward investors for taking on this risk by offering a higher income (or yield). A carefully selected portfolio of investment grade and high yield bonds can provide an attractive income stream, while keeping the amount of risk within the limits that many investors will find acceptable.
Property is also worth consideration. This asset class currently provides investors with a yield of around 5% (according to data from the Investment Property Database), which looks very attractive versus interest rates of 0.25% and government bond yields of around 1%. The yield on property comes from the rent paid by tenants, the level of which is often linked to inflation.
Given these varied opportunities, savers could be well advised to look at the merits of higher yielding investments that offer the prospect of both higher income and the possibility of long-term growth.
* Source: Moneysupermarket.com, 20 October 2016.
Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at November 2016. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.
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