Low interest rates mean changes to the way we save
It seems that low interest rates are here to stay, so savers need to look beyond cash savings and seek refuge in stocks if they want to see a return on their money, says Bill Jamieson
Of all the factors that have held sway over decisions on household savings and investment, interest rates were once the most critical. Hundreds of millions of pounds would ‘switch on a twitch’: a rate rise would send us scurrying into bank deposits while a cut would have experts wringing their hands in despair over ‘negative real rates’ and a slump in the savings ratio.
Today, we are in a new era. It is the age of the ultra-low interest rate. Far from this having been a temporary, emergency measure to avoid recession in the wake of the 2007-09 financial crisis, ultra-low rates are still with us – ten years later – and with every sign that the low rate world is not going to change for the foreseeable future.
It would be logical to assume that low interest rate bank accounts have fallen well out of favour by now. What, after all, is the point in saving this way, when the average rate reward is just 1.5 per cent – and still lower than an inflation rate down to 2.1 per cent?
But instead, we have witnessed a massive surge of money into these accounts – a ‘dash for cash’ without modern precedent. The reason? A huge pull-out of longer-term savings from stock marketrelated vehicles – unit trust and investment trusts. A combination of volatility, a slowing economy and deepening uncertainty over Brexit have caused investors to head for the hills and shelter in cash.
According to the Investment Association, UK investors have withdrawn a colossal £10.8 billion from equity funds since the June 2016 referendum vote. And there is little sign that this exodus is slowing. In fact, the IA’s latest figures show that in November investors pulled £2.1 billion out of funds – the single largest monthly outflow recorded since the referendum.
UK equity funds suffered the heaviest outflows in five of the 12 months to November, with North American funds accounting for a further two. Disillusion has also set in with so-called absolute return funds, which scored the heaviest withdrawals in October and November. Corporate and ‘strategic’ bond funds have also suffered outflows. Overall, out of 13 global equity sectors, ‘UK All Companies’ fared worst.
In this dash for cash, rock bottom interest rates don’t seem to matter. According to UK Finance, more than 250 banks accounting for the overwhelming bulk of cash deposits reported some £652 billion held in easy-access accounts. Just £197 billion was held in fixed term accounts or ones requiring notice of withdrawal.
Investors charged into these accounts seeking capital protection. But, even setting aside the fact that such accounts are offering no protection against inflation, savers’ capital would have been better protected by staying invested.
The virtue of patience – despite volatile markets, worries over trade wars and the deepening worry over Brexit – would have been handsomely rewarded for investors who stayed put. Since May 2008, just before equity markets nose-dived, the FTSE All-Share Index would have brought investors a total return (including dividends) of 77%. And since the Brexit vote in June 2016, UK shares have held up, returning 21% on the same basis, providing greater ‘protection’ than that offered by an easy access cash account.
Now of course, it is always prudent for individuals and households to keep an emergency reserve in cash – financial advisers typically suggest a sum equivalent to three months’ pay. And it is certainly the case that investing in the stock market should