Recent news suggests three Bank of England policymakers have broken rank to push for an increase in the UK central bank’s base interest rate.
The base rate is currently at 0.25%, a historic low in place since last August, intended as a fiscal stimulus to combat market uncertainty surrounding Brexit.
While a boon for borrowing and spending, rock bottom interest rates have the reverse impact on savers and investors. With the base interest rate at 0.5% or less since March 2009, returns lagging inflation has meant savers and low-risk investors have been forced to face the reality that their assets have been losing real value year on year.
Despite the Bank’s stated concern around quickening interest rates, which are expected to move above 3% in the near future, there is significant doubt as to whether it is really ready to move. Despite three policy makers supporting a rate rise, concrete action still requires final approval by BoE Governor Mark Carney.
There are competing concerns that raising interest rates will damage economic growth in a frail Brexit economy and could also provoke a property market slump by pushing up mortgage repayments.
And the reality is that within the context of 2.5%+ inflation, even the mooted return of the base interest rate to 0.5% would fall a long way short of changing the recent anti-savings fiscal environment.
A recent FT Advisor article highlighted that as of mid-June, the best interest rates to be found on easy access and fixed rate cash ISAs are 1.05% and 1.8% respectively. Standard savings accounts now offer negligible/symbolic/pointless (take your pick) interest rates of as low as 0.01%.
The current reality is that any saver or retail investor that wants to achieve returns in line with inflation, preventing the gradual erosion of their nest egg’s value, is obliged to accept at least a small level of risk and turn to investment products.
However, a majority of retail (private individuals who are not classified as high net worth) savers and investors either do not feel competent enough to actively manage investment portfolios themselves or able to make the time sacrifice this would require.
So, for those who fall into this mainstream demographic, what low-risk savings accounts offer a fighting chance of staving off inflation erosion?
And for the more adventurous, which low maintenance investment choices offer an alternative way to make a return?
Robo-Advice Investment Portfolios
The past 2-3 years has seen the rise of robo-advisers. These consist of ‘robotic’ algorithms which automatically select investments from a preferred pool.
There is already around $1 billion in assets managed by robo advisors in the UK. In the U.S., where the market is more developed, that sum is somewhere around $50 billion.
Robo investment advice is less space-age than it may initially sound. Rather than a suited and booted robot dishing out stock market tips and risk management strategies, a robo-advisor is simply an online, automated investment portfolio.
Investors are profiled through a 10-15 question process in the same way as would be the case with a traditional human financial advisor. They are then given an appropriate basket of investments based on risk profile, which is subsequently managed and adjusted on an ongoing basis.
The leading robo-advisory services currently on the market in the UK are Nutmeg and MoneyFarm, though a number of new competitors such as Scalable Capital and Wealthify are also picking up steam. The automated nature of robo advisors keeps costs down, with annual fees usually somewhere between 0.5% and 1%.
While robo advisors are relatively new, meaning track records are limited, Nutmeg’s 10 portfolios, differentiated by risk level, delivered returns of between 2.28% (lowest risk) and 15.36% (highest risk) over 2016. MoneyFarm’s lowest and highest portfolio return for the same period came in at a respective 4.81% and 16.5%.
Also offering investment ISA and SIPP options, robo advisory services are an option worth serious consideration for savers looking for a low-ish cost, low maintenance product to protect against inflation-based capital erosion.
Traditional low-yield, fixed-interest government bonds are not a great bet in an environment of low-interest rates and rising inflation. However, corporate bonds which come with higher returns than government bonds, and if chosen carefully have an acceptable risk profile, are a genuine inflation-beating option.
When an investor buys a bond they are lending capital against a promised return over a defined period of time, in contrast to acquiring an ownership stake in a company through buying shares. As long as the company is able to honour its debt obligation to bondholders, returns are not linked to company performance in the way owning shares is.
An alternative to corporate bonds are specialist bonds such as The Family Building Society’s recently released ‘Brexit Bond’. The bond guarantees an annual 1% return, competitive with most savings products, with an additional 2% gained should the holder correctly predict the movement of the pound’s value against the euro between March 2017 and March 2019.
This is the period between Article 50 being triggered and when the UK is due to leave the EU. The 3% on offer for a correct prediction of whether the pound will fall or rise against the euro over the next couple of years should stave off the negative effects of inflation on capital invested in a Brexit Bond.
Peer to Peer Lending Providers
Rather than lending to a bank via a savings account offering a measly return of up to 1% per annum, peer to peer lending platforms allow investors to lend to businesses and individuals at much higher interest rates.
There is, of course, a risk of default but historical data from the past several years suggests this is not unacceptably high when mitigated by wide diversification, splitting capital loaned into small sums spread between multiple borrowers.
A well-diversified, lower risk profile peer to peer lending portfolio would be expected to deliver returns of around 5%, based on historical data available.
It should be noted that this historical data only goes back several years and the investment format has yet to be tested in a particularly volatile environment such as the international financial crisis of 2007-08.
The biggest peer to peer lending platforms operating in the UK includes Funding Circle, RateSetter and Zopa.
Diversify to Mitigate Risks
Generating returns that are high enough to beat inflation is not easy in the current environment and does involve accepting at least a degree of risk.
However, the three options outlined here, and there are of course other alternatives, do give savers a fighting chance at a risk tolerance level suitable for retail investors.
The principle of diversification (not putting all your eggs in one basket) which is always best practice when it comes to investment choices, of course still applies.
But there is hope, choices are available to you and inflation erosion of savings is not an inevitable fate even with a base Bank of England interest rate of 0.25%-0.5%!