Interest Rate Latest and Why More Savers are Turning to Investments
You would be hard pushed not to hear the continuing speculation around when the next interest rate rise will be, and with good cause. This has the potential to affect all of us and so understanding when this might occur, and the impact it will have, is understandably a top priority. In addition, the recent changes to the ISA rules have resulted in greater flexibility and an increased allowance of £15,000. Although good news for both savers and investors, the former continue to find it tough as savings rates remain low. We take a look at the potential impact a rise in interest rates might have as well as why more and more savers are starting to consider their investment options.
Interest rate latest
Interest rates have remained at their record low for over five years. When Mark Carney took over as governor of the Bank of England, he initiated the Bank’s ‘forward guidance’ which linked a nudge up in interest rates would occur should unemployment move below7%. Since then, there have been increasing attempts to move away from this measure as the unemployment rate dipped quicker than expected. Predictions of when a rise might occur have since abounded with a rise seemingly getting closer and closer, or, as Mr Carney put it when speaking at the annual Mansion House dinner last month, ‘could rise sooner than markets currently expect’. He said that although there is no pre-set course for this to take, ‘2.5% is likely to become the ‘new normal’ level for the base rate by 2017’.
Borrowers set to lose the most
Mr Carney added that any interest rate rise will need to be done slowly and gradually and so a small increase of 0.25% is the most likely first step. Homeowners are likely to have the most to lose from any increase and are the main reason interest rates have to rise slowly. A sharp rise could cause more than a financial headache, especially for those who are already stretched each month and who have not fixed their mortgage rate – two thirds of people are currently sitting on their bank’s standard variable rate which will inevitably edge up as rates start to rise.
This coincides with lenders now wanting to know far more details about income and outgoings before they decide to lend with increasing pressure for them to show that each mortgage is serviceable over its lifetime not just when interest rates are at records lows. This means anyone considering a mortgage or remortgage must be well prepared. Fixing your mortgage can protect you from the impact of a rate rise although we have already started to see an increase in fixed rates. If you would like to research your options or speak to an independent mortgage and protection specialist, please visit Fair Mortgages for further information.
Savers set to gain the most… or do they?
Whilst borrowers have been the real winners of this period of record low interest rates, on the flip side savers have been hit harder than anyone with both variable and fixed savings rates far lower than in previous years – so any prospect of an interest rate rise is welcomed with open arms. Savers were also given a boost by the changes to the ISA rules which took effect on 1st July that now mean you can now invest up to £15,000 entirely in Cash, Stocks & Shares, or any combination of the two.
For cash savers, this new limit is just over two and half times larger than the previous £5,940 allowance, and is equivalent to saving £1,250 per month (compared to the previous £495 per month). On the face of it, the potential for an increase to savings rates along with the ability to transfer existing Stocks & Shares ISAs to cash and add up to a further £15,000 is fantastic news, however the early signs for savers is that they might not have gained as much as first thought.
ISA allowance up, Cash ISA savings rates down
The reality is that the benefits of the New ISA or ‘NISA’ allowance can only be fully utilized if the savings rates on offer are attractive. Whilst savers experienced a less than fruitful ISA season in terms of interest rates from Cash ISAs, many were pinning their hopes on the new ISA limits resulting in new and more attractive deals from providers. Unfortunately, since the start of the current tax year the fact remains that more providers have reduced their ISA rates than increased them.
There is also no guarantee that any rise will follow through to an increase in savings rates on offer and the last few years suggest that the banks’ appetite for your money is not going to return any time soon – they simply do not want your money. The rise of ‘challenger’ banks has lead to some increase in competition but by comparison the rates still remain far lower than in previous years, and this is before we start to consider the potential impact inflation could have in the coming years.
With leading instant access only offering around 1.5% this is equal to the current rate of inflation (as measured by the Consumer Price Index) and so could lose you money if inflation picks up. With anything close to 2% only on offer if you commit for 2 years or longer, this remains a real issue for those uncertain about what will happen to interest rates and therefore reluctant to commit for the longer term.
Indeed, those who have half an eye on a potential rise and who are keen to see where savings rates are going to go from here, may not want to lock into a fixed ISA or fixed rate bond in the short-term. But as banks cut their rates to deter attracting new savers and slash rates for existing customers coming to the end of their initial deal, it is the shorter term rates that are proving most uncompetitive as the prevailing market brings with it a real dilemma for many savers – either lose money in real terms from a savings account, or take on more risk.
Savers looking to investments
This difficult question of taking on more risk to try and combat the effects of inflation and realise competitive returns over and above inflation is one which more and more savers are having to face. Obviously putting your capital at risk is something which you should consider very carefully indeed, particularly if you are considering this for the first time with some of your Cash ISA savings or new ISA money.
This conundrum combined with greater flexibility around ISAs means the opportunity to consider investing is increasing. Certainly the increased ISA limit offers a good reason to reassess any ISAs you have already, as well as consider where is the best home for any new savings – and since you can put up to the maximum in any mixture of Cash and Stocks & Shares, the opportunity is there for the taking to ensure you are putting as much away from the tax man as you can.
Defined return, defined risk
Our most popular investments are fixed term investment plans, offering a defined return for a defined level of risk. This means at the outset, you know exactly what has to happen in order to achieve the stated returns on offer. The investments are designed to provide either income or growth, and normally have a fixed term although some have the ability to mature early. Some also include a defensive element which means you can achieve high returns even if the stock market goes down slightly.
Some capital protection against a falling market
A popular feature of these investments is what is known as ‘conditional capital protection’. This means that your initial capital is returned at the end of the investment term, as long as the underlying investment (the FTSE 100 Index or a number of shares) has not fallen below a specific level or a percentage, normally 50% of its value at the start of the investment. These plans therefore offer some capital protection against a falling stock market. Your capital will be at risk if the Index does fall below the defined level, in which case your initial capital will be reduced by 1% for each 1% fall and so you could lose some or all of your initial investment.
However, if the thought of risking your capital is a step too far, there is a middle ground which offers the potential for stock market linked returns but without risking your capital by combining a deposit with an investment, where the return is not guaranteed but rather dependent on the performance of some underlying asset, often the FTSE 100 Index.
These structured deposits bring with them full capital protection and are eligible for FSCS protection up to the normal deposit limits, whilst linking your return to the stock market replaces a fixed rate of interest with the potential for a higher return. Combined, this provides an alternative savings plan that offers a middle ground between a traditional fixed rate bond, where your capital and return is guaranteed, and an investment where neither your capital nor any return is guaranteed.
Weigh up all of the options
Speculation around interest rates will no doubt continue but for savers and investors, the key consideration should be what impact this might have on the return we receive compared to the needs from our capital. We should ask ourselves exactly what we are buying before committing to a product and consider what alternatives are available, especially in light of the New ISA rules give us greater freedom and increased investment limits.
Ultimately, which option or blend of deposits, structured deposits and investments will depend entirely on your individual circumstances however, the impact of inflation, the timing of any interest rate rises and the potential impact this could have on the savings rates on offer are all relevant factors when deciding what to do. As a minimum we should make sure that all of the options available are weighed up very carefully indeed.
No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Tax treatment of ISAs depends on your individual circumstances and is based on current law which may be subject to change in the future. Always remember to check whether any charges apply before transferring or switching an ISA.
Structured deposit plans are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
Structured investment plans are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.