Low interest rates: is there a solution?

People who are either living off their accumulated wealth or trying to save for the future. So what, if anything, could or should be done? 

The main reason people like to save with a bank is the perception that it is completely secure; your savings value should never fall (although as we have seen in Cyprus, Greece and Iceland, nothing in life is ever 100% certain!). However, people fail to consider a longer-term risk of bank saving: inflation.

Of course, there have been times when interest rates have been much higher than today, but these periods have often coincided with periods of higher inflation. Data going back to 1956 shows that average building society interest rates (net of basic rate tax) have lagged inflation by over 1.5% per year on average over this entire period.

So, although the issue may be more obvious at the moment, the current meagre nominal interest rates are really not that unusual in real terms (ie after inflation). This has some serious implications for longer-term savers, both now and in the future. For example, if you’re aged 60, and living off your bank interest, an inflation rate of just 3% a year will cut your real spending power by almost half by the time you reach 80!

What you need to do then, is decide whether you are happy to move out of traditional cash savings into other types of investment. The reality is that it’s inevitable that at some point the nominal value of your investment will fall. For some people, this completely puts them off any form of investment. In the longer term, however, investments linked to tangible assets such as company shares or property, are much more likely to maintain or even increase their relative value. By shifting money out of the bank you are in essence trading inflation risk (highly dangerous, but almost unnoticeable) for investment risk (generally short-term, but often very easy to spot).

Many people hope I can predict which of these different types of asset, or even specific shares, are going to perform well, and which ones will not. Speculation like this makes for interesting debate but, unfortunately, the evidence is that it’s unlikely to pay off. The majority of professionally-managed funds actually do less well than the market average by some way.

Thankfully, the risk of investment losses can to a certain extent be minimised, without the need for a fortune teller. Spreading your investment over time reduces the risk that you buy at a market high, but most importantly you need to ensure that your portfolio is well diversified, both within markets and across different types of asset. The actual mix will depend on your desired outcome, together with your willingness and capacity to suffer short-term losses.

Being able to hold your nerve is also key to successful investing. Too many people buy high and sell low, not vice versa.  In fact, I’d like to think that the biggest value I bring to my clients, in investment terms, is more considered and rational thinking, helping them to balance both the fear and the greed that can be so damaging to their long-term financial health.

Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.

Article is accurate at date of writing.