Question: The recent cut in interest rates affects me as a retired person. It looks as if my income will fall further. What would you suggest I do?
Answer: The bold move by the Bank of England to cut rates by 1.5% to 3% was an attempt to stave off the effects of recession.
It also looks like further cuts are likely as we go through 2009 as the bank attempts to kick-start the economy again. While all this is good news for those borrowing from the banks, it is, as you say, not good news for investors.
The rate cut has meant many banks have been forced to reduce
rates, particularly those who are now effectively in state ownership.
I was surprised to read recently that they are now complaining, that with rates lower than they have been for over 50 years, their margins are being squeezed and that any further rate cuts will not be passed on to borrowers.
What they failed to say was that if rates were cut, they would pass those reductions by way of lower interest rates to investors.
As is the usual scenario with the banks, they are slow to cut rates for borrowers, but swift to pass reduced rates for investors.
But whatever the rates offered either now or in the near future, one thing is certain, those who are relying on deposits to supplement their income are facing a bleak outlook. For a higher rate taxpayer, the return is now looking like 1.8% per annum after tax.
Whilst inflation looks as if it has peaked and started to fall again, in real terms this means that a depositor’s return is falling significantly year on year.
If we now look at the returns from deposits based on income from other asset classes we are seeing an interesting picture starting to emerge.
The average dividend yield from the FTSE 100 companies now stands at 5%. Ten-year gilt returns are also showing similar returns at just under 5%.
Even higher yields can currently be achieved from what are known as corporate bonds.
These are issued by companies who need to raise capital, and are graded according to the risk of that company defaulting on their obligation of repaying the funds.
The safest form of corporate bonds is classified as investment grade, and will include companies such as Marks & Spencer.
These are currently generating an income of almost 8% for an investor. Finally, property, due to the current collapse in capital values, are also showing healthy income returns of somewhere in the region of 7%.
So as you can see, non-cash assets are now producing a significantly higher return than monies on deposit. Part of the reason for this has been the collapse in capital values recently, and this is where the dilemma lies for any investor who is seeking an income and/or capital growth.
This is down to the fact that cash is ultimately protected from capital risk, although recent events have highlighted that this is only protected to a certain amount. Once someone moves from cash into another asset class such as property, they are ultimately putting their capital at some sort of risk.
\[Mark Sterling\]This risk can be minimized by carefully selecting how to participate in that asset, and also by what is know as diversification. In essence this means not putting all your eggs in one basket by spreading it around various assets.
In doing this an investor over the longer term should be able to produce a better return than cash, although that journey will not be as smooth as simply holding the money with a bank or building society.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact email@example.com or (028) 9022-1010