Low Interest Rates – Looking To Beat The Banks

11.08.10

Please note that this article is over six months old. While Blevins Franks takes care to make sure that information is accurate on the date of publication, some content may change over time. You should not rely on the accuracy of legislation and tax information in this article; take professional advice for your circumstances.

At its August meeting, the Bank of England?s Monetary Policy Committee voted to keep the UK interest rate at 0.5% for the 17th consecutive month. In all likelihood we have many more months of low

At its August meeting, the Bank of England?s Monetary Policy Committee voted to keep the UK interest rate at 0.5% for the 17th consecutive month. In all likelihood we have many more months of low rates to come. Roger Bootle, one of the City?s best known economists, has again warned that ?interest rates could stay at 1% or below for several years yet“.

Prior to the meeting, business groups had been urging the banks to maintain low rates. David Kern, chief economist at the British Chambers of Commerce, argued: “British business will find it difficult to drive a lasting recovery without a prolonged period of low interest rates. Any serious consideration of raising interest rates should be off the table until the second quarter of 2011 at the earliest.

At the end of July, the chief economist of the highly respected Ernst & Young ITEM club, Peter Spencer, said if the government goes ahead with all its proposed spending cuts, interest rates would have to be kept low for longer than markets have anticipated and could remain at 0.5% until the end of 2013.

BoE Governor Mervyn King recently stressed the importance of sustained economic growth and hinted at further stimulus measures. He told a committee of MPs there had been no discussion of “applying the brakes” yet.

Most investors wish to earn greater levels of return than is currently available from cash on deposit. Even if you do not need your savings to generate income, the low interest rates mean that your capital is not growing in real terms, or only minimally. Over the longer term its spending power will diminish, more so if inflation resurfaces over the coming years.

It is generally accepted that over the long term equities provide the best opportunities to outpace inflation. If you do require your capital to generate income, you could invest in a high dividend equity fund. They provide both regular income and the potential for capital growth over the medium to longer term.

If you do not want to invest directly in equities, either because you are a lower risk investor or have enough exposure to equities in your portfolio already, one alternative is a bond fund. They also pay regular interest, usually higher than a bank account, as well as offering the potential for capital growth over the medium to longer-term. Income be can accumulated in the fund to increase capital growth potential if you wish.

Bonds are usually less risky than equities, but capital values can still rise and fall according to prevailing conditions. The income levels, however, will not necessarily be impacted in the same way ? over the recent financial crisis, for example, the income held up well.

If you are seeking capital protection for your capital and do not need income, you could consider a capital protected investment fund. These funds allow exposure to rising equity markets but without investment risk to capital.

The key for the risk averse is to select a fund that offers a 100% capital protection. Even if markets fall over the term of your investment, you will not lose any of your original capital. You will receive your entire investment back at the end of the term (provided you hold it till the closing date). If markets rise over the term, the fund will provide a return linked to a major world stockmarket index or indices.

Capital protected funds can therefore be an attractive alternative to cash for medium term investors seeking the potential for improved returns above those available on cash deposit.

They also work well as a risk reduction strategy in an investment portfolio. Holding a diversified portfolio always helps to lower risk. Including a 100% capital protected fund as part of the diversification lowers risk further.

These funds can also be used to secure investment profits or as a defensive measure.

Note that with capital protected funds you will need to tie your capital up for a fixed period, normally five or six years, so this is only suitable for money you are saving for the future and do not need to access. The funds do not provide income either. You can usually make a withdrawal or encash it if necessary, but this would affect the amount received and the capital protection so you should plan to hold it full-term.

A risk on such an investment is the loss of any bank interest you would have made had you left the money on deposit, but if you expect interest rates to remain low for some years this may not be a significant risk.

Also bear in mind that if equities perform well over the period, the returns are unlikely to be as good as direct investment into equity markets – but the capital protection makes this an acceptable compromise for many. You could of course invest some capital directly into equity funds and some into a capital protected account, to balance out the risk and return element.

It is important that you understand that the capital protection is dependent on the guarantor meeting its obligations. You should therefore check out the institution which provides the capital protection. A ?too big to fail? bank is likely to be suitable, given they are in effect guaranteed by their respective governments.

There are various types of structured products on the market, and although at a glance they can appear similar, some are more risky than others and you may be better advised to leave your money in the bank. It depends on how they work and the protection offered. A reputable financial adviser like Blevins Franks will guide you through your options and establish whether a capital protected investment fund would be appropriate for your objectives.

By Bill Blevins, Managing Director, Blevins Franks

9th August 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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