A decade of low interest rates: Cash loses £265 in real terms but UK equity income triples

6 March 2019 - This week marks two big milestones: it is the tenth anniversary of stock markets hitting rock bottom in the wake of the global financial crisis, as well as the decision by the Bank of England to cut interest rates to ‘emergency levels’ of 0.5%.

The decision to cut rates a decade ago (March 5) was the sixth cut in six months – from 5% in October 2008 to 0.5% in March 2009 – the final cut brought rates to the lowest level since the bank was founded in 1694. A few days later, the UK stock market hit a low of 3,512.

Ten years on and, while rates have crept up to 0.75%, they still remain at a very low level historically.

And, while we are not be facing the Armageddon scenario cited by some commentators at the height of the financial crisis, the uncertainty around Brexit, coupled with wider geopolitical worries globally, means the consensus among many is interest rates will remain at subdued levels for some time to come.

Cash not king as savers lose £265 in real terms

In order for savings to grow, the interest rate on an account needs to be higher than the rate of inflation. However, in most instances this has not been the case. The current inflation rate, as measured by the Consumer Prices Index, stands at 1.8%, yet the highest paying easy access Cash ISA currently pays around 1.5%.

Anyone who kept cash savings in the last decade will have missed out on stock market gains. Moreover, while a full cash ISA allowance of £3,600 in a savings account paying the base rate would today be worth £3,777*, it would only be worth £3,335 – a loss of £265 - once inflation has been taken into account**.

10 year stock market returns dwarf cash

Investing in equities carries a much higher risk profile than cash, but the potential rewards can be far greater than those generated by cash. For example, the average fund in the IA UK Equity Income sector has returned 194.6%*** in the past 10 years. Meanwhile, for those who chose to look for income overseas, the returns have been even greater, with Global Equity Income funds returning 210%*** on average over the past decade.

Assuming all dividends are re-invested it would mean an investment of £3,600 into the IA UK Equity Income sector and Global Equity Income sector would now be worth an average of £10,603.80*** and £11,161.44*** respectively.

Those looking to take on less risk in the average UK Corporate Bond fund would have seen an investment today of £6,992.64***.

At Chelsea we expect it will be a long-time before we see interest rates back at the level we saw before the global financial crisis. At best we will see small, incremental increases over time, although this is unlikely to even start to materialise until later this year at the earliest.

Below are four funds investors could consider instead of cash – bearing in mind they all carry extra degrees of risk.

Rathbone Income

This fund is run by an extremely experienced manager in Carl Stick and has one of the best track records in the sector for raising dividends annually over a period of almost 25 years. The investment process uses ten core stock selection principles and revolves around three areas: risk management, quality and value. Company meetings and further research is then undertaken to build a portfolio of around 40 to 50 businesses.

Guinness Global Equity Income

This fund is slightly different to most of its peers, as it typically consists of around 35 equal-weighted stocks. This practice means that investments are very different from the benchmark index. The managers also have substantial freedom to entirely avoid countries and sectors they don't like. The fund aims to provide investors with both income and capital appreciation and shares in companies are generally held for three to five years.

Royal London Corporate Bond fund

The manager of this fund has, over a long period of time, proved adept at delving into parts of the fixed income market where others fear to tread and identifying issues that offer superior risk-adjusted returns. He invests predominantly, but not exclusively, in investment grade corporate bonds and the process is risk aware: he concentrates on avoiding losers rather than picking big winners, to provide an attractive and stable yield over time.

*Source: FE Analytics, 4 March 2009 to 4 March 2019, total returns in sterling using the Bank of England base rate.
**Source: Consumer Price Index data from ONS, December 2008 to December 2018 - The data shows the value £3,600 in cash in March 2009 would be worth in December 2018 when taking into account added interest and the impact of inflation on real returns.
***Source – FE Analytics, 4 March 2009 to 4 March 2019, total returns in sterling for the IA UK Equity Income, IA Global Equity Income, IA Sterling Corporate Bond, IA Sterling Strategic Bond, IA UK Smaller Companies and IA Emerging Markets sectors.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius's views are his own and do not constitute financial advice.

Published on 06/03/2019