Interest Rate Increase – Investing In The Stock Markets

Please note that the value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

Last month, the Monetary Policy Committee (MPC) of the Bank of England raised the bank rate to 5%, the highest level since 2008, in an effort to fight inflation which has remained high at 8.7% in May. Raising interest rates have hit borrowers hard, particularly for people who have variable mortgages and those looking to either buy a property or rebroke their existing mortgage deals.

It’s not all doom and gloom, however. The increase in the bank rate has led to an increase in rates being offered to savers, and at the time of writing, some providers are offering a three-year fixed savings account with up to 6.10% per year return or for those who don’t want to put their money away for long periods of time, up to 4.07% for easy-access accounts.

At Nelsons, we firmly believe that everyone should have easily accessible cash for emergencies and short-term expenses. A good minimum to aim for is at least three to six months of your expenses.

Considerations

With interest rates still forecast to increase higher, many people may be wondering if there is any advantage to investing in the stock markets, especially when savings account rates are so high. This largely depends on a variety of factors such as:

If you need easy access to your capital, a fixed-term savings account may not be the best option for you. Although the rates are competitive, you are usually not able to withdraw from the account before it matures. Or, if you can, there may be penalties that can reduce any interest earned on your deposit.

If you are not comfortable with investment risk, a fixed-term savings account may be preferable. These accounts benefit from the fact that the interest offered is not based on the markets and therefore you have certainty that you will achieve a return if you hold the account to maturity.

However, inflation may still reduce the spending power of your capital if inflation is higher than your account interest rate.

If you can only afford to put your money away for the short term, i.e., up to 5 years, a fixed-rate savings account may be a better option but if you are able to invest for a longer period, i.e. 5-10+ years, an investment in the stock markets may be a better option.

Considering the performance of a balanced index fund against the Bank of England rate +2.5% & the retail price index (RPI) over 10 years, the benefits of longer-term investing can be seen.

Historical Comparisons

Red – RPI
Black – Balanced Index Fund
Blue – Bank of England Rate + 2.5%
Source: F.E Analytics

*Investing carries with it a degree of risk and you may not receive back what you put in. Historical performance does not guarantee future returns. Returns quoted are gross of fees.

Summary

When coupled with a holistic financial plan, investments in the stock markets do have the potential to perform well over the long term. However, fixed-term accounts may be better for those who can only commit to locking their funds away for a shorter period of time. Which investment strategy is best for you is entirely dependent on your attitude to risk, goals and objectives and financial position.

A financial adviser can help to formulate a financial plan on your behalf, taking into consideration, your objectives, personal situation, and risk preferences.