Interest Rates at 0.5% Since the Last Election – the Impact on Savers

Following yesterday’s interest rate decision, we now know that interest rates will have been kept on hold at 0.5% for the whole term of the Coalition’s rule (and more).

  • £1,000 deposited in cash at the last election is now worth £936 in real terms
  • Money in non-interest bearing accounts has almost doubled
  • How this compares with rates under the previous government
  • Interest rate expectations
  • Options for savers

Since the last election, savers have seen £1,000 held on deposit at the bank turn into £1,045 today, on average. Over that entire period CPI inflation rose 12%, so in real terms that £1,000 is now worth just £936. In other words, cash savers can now buy less stuff with their money.

Meanwhile the amount of money in non-interest bearing deposit accounts has almost doubled, from £79 billion in May 2010 to £153 billion today.

Laith Khalaf, Senior Analyst, Hargreaves Lansdown:

‘Cash savers have been plum out of luck since before the last election, and it doesn’t look like their fortunes are going to change any time soon. Cash is often perceived as carrying no risk because it won’t fall in value, but the danger is your money falls behind inflation, and so you see your spending power gradually eaten away.

Savers should use cash to meet any short term spending needs, and should keep an emergency fund of around 6 months’ salary in cash. Beyond that savers should consider taking a bit more risk and investing, to try to beat inflation and deliver better returns over the long term, though if you take this route you have to accept there will be falls in the value of your investment along the way.’

How this compares with the previous government

Cash on deposit did a bit better under the previous government, £1,000 saved into the average deposit account in May 2005 was worth £1,127 in May 2010. However CPI inflation ran at 15% over this entire period, so that £1,000 would still have fallen in value in real terms to £984. In other words, still going backwards after inflation is taken into account.

Meanwhile, the amount of cash held in non-interest bearing deposit accounts more than trebled, from £21 billion in May 2005 to £79 billion by May 2010.

Interest rate expectations

The market currently expects UK interest rates to rise around the middle of next year, and expects us to enter 2017 with rates still below 1%.

However the market has been woefully premature when it comes to predicting interest rate rises. At the end of 2009, months after interest rates had been cut to 0.5%, the market still expected rates to be back to 4% in 2012.

Even when interest rate rises appear, they are likely to be slow and gradual, and savers are unlikely to find them a great help in alleviating the pain they have now been enduring for the better part of a decade.

We surveyed over 1,000 savers who transferred from a cash to a stocks and shares ISA; on average they wanted an interest rate of 4.5% to tempt them back to cash. That sort of interest rate isn’t even on the radar at the moment.

Options for savers

Savers have been wedged between a rock and a hard place by loose monetary policy. Given low rates of return on cash, they might naturally turn to bonds to produce an income. However low interest rates and Quantitative Easing have driven bond yields down too, and these now offer scant compensation for the possibility of capital losses.

Investing in the stock market is the other option for long term savers. The longer you are willing to squirrel your money away for, the greater the chance investing in the stock market will reward you more than cash.

Over 5 years the UK stock market has beaten cash 75% of the time, over 10 years it has beaten cash 91% of the time, and over 18 years it has beaten cash 99% of the time, according to the Barclays Equity Gilt Study, which analyses returns going back to 1899.

The stock market is of course riskier than cash; your investment can, and will, fall in value. However cash is not entirely risk-free; as the numbers above illustrate, cash comes with a big risk of falling behind rises in the prices of goods which savers spend their money on.

Fund ideas

Here are a few funds investors might consider if they are looking for alternatives to cash, are happy to save their money for the long term, and accept that their investment will fall in value, and they may get back less than they invested.

1. Income-seeker: Woodford Equity Income

Neil Woodford is a contrarian buy and hold investor who is not afraid to step out of line with his peers. This approach led him to shun tech stocks in the late 1990s and banks in the run up to the financial crisis, shortly before these sectors sold off sharply. As a custodian of long term investments there can be few better candidates. The current yield on the fund is 4% (variable, not guaranteed).

2. Conservative investor: Newton Real Return

The primary focus of this fund is capital preservation, though it can and does fall in value. The fund is constructed as a core portfolio of equities and bonds which can be supplemented by positions in cash, currencies and commodities. This is a long running fund with an excellent track record of protecting investors while generating decent returns, and deserves consideration by conservative investors.

3. Long term growth investor: Lindsell Train Global Equity

Run by management duo Nick Train and Michael Lindsell, this is a concentrated portfolio of around 30 companies, hand-picked by the managers for being top quality, global businesses which the fund can buy and hold for the long term. The fund is only 4 years old, but we have assembled portfolio data to analyse the managers’ performance on other global mandates going back to February 2001.  Over this period they have returned 309%, compared to 94% from the MSCI World Index.

Main image: Duncan Harris @ Flickr

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