February 2009
HOW TO AVOID DIMINISHING RETURNS – Part
one
By David Stearn, Head of Business
Development, Fairbairn Private Bank
As the financial turmoil and economic
slowdown look set to continue into 2009, it is becoming more and
more difficult to find effective means of maintaining returns ahead
of inflation. In an environment of falling house prices and record
stock market falls, preserving capital is becoming a challenge.
Investors have therefore become increasingly risk averse and the UK
and US witnessed a significant move into cash deposits.
With central banks now pursuing an
aggressive rate cutting policy in their effort to aid economic
recovery, cash as a capital preservation shelter, whilst still
popular, is not offering the return it once did. At the current
time, with sterling base rate at 1.0% (the lowest level in the Bank
of England’s 315-year history), the euro base rate at 2.0% and the
US fed rate effectively 0.0%, returns are below inflation. It seems
likely that a low interest rate environment will prevail for some
time to come and you may be concerned by this prospect of
diminishing returns on your savings, therefore we wanted to provide
you with some options and food for thought.
Before looking at the options, savers
firstly need to remember that along with interest rates, inflation
rates are also tumbling and deflationary forces are looming large.
Whilst accepting negligible interest rates frequently hurt savers,
if inflation turns negative, in real terms, the outcome can still
be positive. In an environment where goods and services become
cheaper, savings become more valuable in terms of spending power.
New thought processes may well become necessary in the short term,
but one truism will always remain: chasing returns above the market
norm will always be a high-risk strategy. However, the two options
we detail below are considered low risk in terms of loss of
capital.
Option 1: Fixed term deposits
If you do not need instant access to your
cash, you could lock your money away for a fixed period; a fixed
term savings account would be the simplest option. The rates
currently offered increase in proportion to the length of time you
are prepared to fix the deposit – the longer you are prepared to
lock up your money the higher the interest rate you will be
offered.
Should you choose this form of deposit, you
could increase the interest rate earned. Full details of our
current fixed term deposit rates can be found on our website.
As many economists are predicting further
base rate cuts this year, falling inflation and, possibly,
deflation, these longer term rates could very soon look
compelling.
Option 2: Cash funds
Cash funds are pooled investment vehicles that
offer a flexible and stable alternative to bank or building society
accounts. By investing into a cash fund you achieve diversification
benefits because the fund manager invests into a range of cash, or
near cash, instruments, designed to increase returns above vanilla
bank deposits. Cash funds offer competitive rates of interest
coupled with the flexibility to access your savings at any
time.
As outlined above, because cash funds can
hold assets other than deposits, for example, securities such as
commercial paper that carry a higher risk than cash, careful fund
selection is imperative. We can guide you in this area and
currently prefer those funds that offer a well-balanced range of
assets without commercial paper.
We can also source accumulation cash funds
where your investment can be left to build up without interest
being paid. This could have certain tax advantages depending
on your tax status. With this type of fund, you only become liable
for tax on the sale of your units.
Given the prospect of continued volatility
and low interest rates in the foreseeable future, you may be well
advised to consider an alternative to simply leaving all your cash
on deposit. To talk through your individual circumstances and find
out more about these and other options available, please contact
our client services team on +44 (0) 1624 645000.
Part
two is available to view online.