Higher Interest Rates & Investing

With interest rates rising and expectations they will increase again, many savers will see much better rates for their cash than say a year ago. At the time of writing, Atom Bank is paying 4.11% for its one-year bond.

Although it’s important to hold cash for security and short-term expenses, it’s still not the best hedge against inflation longer term.

Investing involves taking a degree of risk, but not all investments are high risk. Many investors and in particular Trustees who look after money for vulnerable beneficiaries or Personal Injury Trusts, adopt a lower, cautious approach to investing.

With interest rates higher, they may be wondering is investing still worth it?

Although low risk can be a tricky area, corporate bond funds, which are issued by a company to raise money, are now paying 4-5% in terms of coupon (regular interest payments) but with good potential for capital upside, as they have all sold off so heavily.

If (and more likely, when) we have a recession in the UK, the Bank of England will have to switch to cutting rates and this will mean that investors get both the income (4-5%) they would have received from the cash deposit account, but also the capital upside.

Reasons for investing

There are of course other reasons to invest in a portfolio. The equity market is now trading on much more attractive price-earnings. The price-earnings ratio is the ratio of a company’s share price to the company’s earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.

From current levels, you would expect significantly more upside than 4% a year and this will be much more closely linked to inflation concerns. Getting 4% on a savings account is nice compared to what we are used to, but if inflation continues for a prolonged period then you will still be going backwards, whereas good quality equities will pass inflation on to their customers.

We’ve already felt a lot of the pain in equity markets from the current market outlook and earnings have actually risen this year in the S&P. The S&P being an index of 500 leading publicly traded companies in the U.S. That’s not to say we aren’t at the bottom of the market but given current valuations, there is a lot of value now.

Comment

Overall even a low/medium risk portfolio has the potential to produce higher returns, and a much higher net return when you consider the tax advantages available when investing, for example, ISAs, using Capital Gains tax allowances, pension tax relief, etc. versus a savings account.