Long term savings - the opportunities and risks

Monday, 9th May 2016 14:05 - by David Harbage

1. Cash - This is the first in a series of articles that have been written to help the reader make sensible plans about their finances. Qualified in banking and stock exchange exams, a registered advisor and an investment director at a high street bank, the author believes that individuals can benefit from learning more about the merits and shortcomings of the various assets put forward as solutions for long term savings.

A consequent, greater knowledge - accompanied by a better understanding of the potential risks, rewards and drivers of returns or performance – can lead to the interested saver asking intelligent questions of advisors, gaining more comfort and ultimately taking greater ownership of the investment plan or solution. Besides being educational, we hope these pieces will provoke discussion, eliminate a few information ‘blind spots’ and prompt readers to consider their own finances or revise any existing investment plans.

Without wishing to insult anyone’s intelligence, we intend to start with a few basic facts or theories although anticipating that most readers of this article – probably being Do-It-Yourself investors - possess higher than average knowledge of things pertaining to money, and especially stock exchange matters. Investment is a mixture of science and art, with received wisdom surrounding fundamental truths and strong historical precedents being challenged by new economic landscapes. One thing seems to change less, and that is human behaviour and responses to major events and calamities in particular – more of which in a future article. For now, we suggest that the ideas and views expressed represent best endeavours at shedding light into what is undoubtedly an ever changing subject matter.

Cash – what is it, and what is it not, for the long term saver? Vital as a benchmark of how the total pot of money might perform, but history indicates that cash is far from being the ideal asset for an investment of more than five years’ duration. Cash, by which we mean bank or building society overnight rate £ monies, provides a source of comfort as a readily available means of providing for unforeseen ‘rainy day’ bills or, as the professional investor would say “meeting short term liabilities”. It is sensible to retain your assets in sterling, the currency of such liabilities; foreign exchange represents an unnecessary additional risk, which we will discuss later when considering more speculative investment.

Since 1 January 2016, the first £75,000 (reduced from £85,000, as the sum is based on an EU directive of Euro100,000) of an individual’s cash deposit per bank or similar savings institution could be perceived to be ‘safe’ as financial losses will be compensated (please see Financial Services Compensation Scheme website). The FSCS only covers up to £50,000 cash per person, per stockbroker. But beyond such a risk – mitigated as savers spread their liquid monies in excess of £75,000 beyond one bank – the prime disadvantage surrounds the current offer, and the uncertainty of future returns, on cash. With Bank rate (more commonly known as base rate) currently at an all-time historical low of 0.5%, it certainly lacks appeal. Especially if this nominal interest rate is considered in real terms; i.e. after taking account of prevailing inflation – meaning that most bank, building society or National Savings’ accounts are offering a zero or negative real return to their savers. 

However, it is the unpredictability of future interest rates (to say nothing of wondering whether those returns will add value by enhancing purchasing power) that perhaps represents the greatest negative to cash being adopted as a core asset for the long term investor. History shows that interest rates are likely to both rise and fall, but rarely in a logical direction and via moves of predictable magnitude. The UK’s Bank rate is no longer controlled by politicians – but rather by the Monetary Policy Committee (MPC) of the Bank of England, which set rates with the prime aim of keeping consumer price index (CPI) inflation around 2%. Policy makers are unlikely to countenance significantly higher overnight rates (to the point of cash offering a positive real return) until firm evidence of a stronger domestic economy, and in particular, inflation emerges. Accordingly, based on the absence of the latter, one can expect Bank rate to remain unchanged in the foreseeable future. The major financial institutions, under pressure to conserve cash and strengthen balance sheets, are unable to offer attractive rates on large sums to individual savers - beyond rewarding regular monthly and Individual Savings Account savers (both of which limit the monies that can be deposited) with incremental headline rates on new monies.

By contrast with the unreliability of its returns, retaining cash (or liquidity, as professionals typically describe such reserves) assets can be a useful means of preserving monetary value in the short term - until the right opportunity presents itself to make a longer term investment into what might be considered a more appropriate asset. Essentially it is a means of finessing or timing the purchase of other assets. We will discuss some of those alternatives, from buy-to-let property to stock exchange securities, from foreign currency to gold, in due course – as well as investigate some of the risks associated with the timing, the various ways of taking an interest in or delegating management, and the factors that propel or hinder performance of both traditional investments and exotic, perhaps esoteric, assets. 

The next article will investigate the prospect of obtaining higher rates of interest, more certain fixed rates and consider how inflation-matching returns might be achieved from cash-like investments. But be warned, all asset types feature both positive and negative factors; moreover the relative desirability or suitability of any one class or kind of investment will differ according to the personal circumstances of the individual. So our first effort to analyse the long term savings opportunity - or the financial ‘jungle’, as it is sometimes described by the confused or bemused - concludes with the well-worn, but nevertheless useful, recommendation that an investor should ‘never put all eggs into a single basket’ but rather spread monies across various asset types and places.   

 David Harbage 

26 February 2016

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.