Interest rates have been hovering just above zero since 2008, stuck in what feels like a permanent trough. As a result, those looking to draw an income from their savings have found that the traditional means of procuring it can no longer deliver.

Interest rates have been hovering just above zero since 2008, stuck in what feels like a permanent trough. As a result, those looking to draw an income from their savings have found that the traditional means of procuring it can no longer deliver.

Back in 1986, investors were promised an annualised yield of 15.6% from a 30-year government bond (‘gilt’). Today, the equivalent 30-year bond would deliver just 1.8%.1 That’s good news in terms of servicing the national debt, but bad news for savers and pension savers in particular.

The value of annuities – the insurance products that can provide an income for life upon retirement– is linked to gilt yields. This means that annuity incomes have also fallen to historically low levels, and would-be retirees face a quandary – should they lock in measly yields, or run the risk of living to see their pension pot run out?

The most recent drop in interest rates was the result of action taken by the Bank of England following the UK’s vote to exit the EU. This followed the prolonged period of quantitative easing in the wake of the 2008 global financial crisis, which depressed gilt yields to historic lows. There’s little to suggest that interest rates will return to mid-single digits any time soon.

What this of course reiterates is that holding cash, rarely the sensible option, offers little in the way of reward since interest rates are so low they hold no hope of outpacing inflation.

Pressure points

For high-net-worth individuals, who face heightened inflationary pressure, the collapse in savings rates has been felt acutely. The cost of paying for private education, for example, has risen by an inflation-busting 21% in the last five years,2 while figures from the Office for National Statistics show that in the first quarter of 2016, the cost of paying for items such as hotels and restaurants increased faster than prices in other consumer sectors.3

On average, we’re also living longer thanks to improvements in healthcare and overall healthier lifestyles. This combination of increased longevity, low interest rates and rising inflation is particularly challenging for anyone engaged in long-term financial planning and for those targeting an income stream to last them through retirement.

Finding freedom

Fortunately, recent government policy has recognised the shortcomings of annuities and from April 2015, those aged 55 and over have been able to draw their retirement income from a defined-contribution pension plan with complete freedom.

This new pension regime means you’re no longer bound to purchase inflexible annuities, but also involves a set of difficult decisions about how and where to invest for the future.

To beat the wealth-draining combination of low interest rates and sharply rising inflation, and to take advantage of pension freedom and choice, you’ll need to look beyond the security of gilts and consider asset classes with the potential for greater returns. With the support of a financial planner, as a long-term investor you can choose from a number of options to help diversify your portfolio.

Taking stock

The MSCI World index, representing the performance of the largest companies across developed economies, reported annualised returns in pounds sterling of 8.6%4 for the ten years to the end of October 2016 – a period that includes the financial crisis of 2008 and the Euro zone debt turmoil of 2011. Over the same ten years, funds held in a savings account would have grown by a paltry 1.8% on an annualised basis.5

Of course, the journey for stocks has been far more volatile, at some points being down almost 35% from their peak.6 The next ten years may also produce a different result. If you’re not comfortable with such oscillations, or you rely on your capital to meet near-term commitments, this level of risk wouldn’t be appropriate.

What should also go without saying is that past performance of stocks is no guarantee of the future; you’ll need to accept the possibility that markets may underperform for quite some time.

Keeping risk under control

You may want to think about adding other asset classes to your portfolio – just remember that they’ll bring their own unique sources of risk and return too.

For example, looking beyond high-credit-quality bonds can help generate income and growth. While investing in a handful of high-yield bonds can be dangerous, a fund of them can mitigate the potential losses on any single one. The Bloomberg Barclays High Yield Bond index, a representative benchmark, currently offers a yield of 6.4%,7 though you could lose money over both the short and long term if interest rates were to rise significantly and for a prolonged period, or if companies were perceived to be less likely to repay their debts.

Through a blend of asset classes, it’s possible to construct a portfolio that’s pitched at the right level of risk for you, while taking advantage of diversification benefits too.

Taking a broader view of your wealth

Low interest rates may be bad news for savers, but they also make it cheaper to borrow money—for example, by re-mortgaging a property. If you were to invest the proceeds, this could potentially be a way to enhance your overall returns. However, it’s important to remember that leverage amplifies movements on the downside as well as the upside, so it may not be appropriate if you’re unwilling or unable to accept this risk.

Insurance is another option for long-term financial planning. While annuities look like poor value, there are still ways to incorporate insurance guarantees into your portfolio.

Whole-of-life insurance policies, which pay out a cash lump sum irrespective of when you die, may prove beneficial as part of tax planning. These policies can be exempt from inheritance tax if they’re included as part of a trust. Premiums are guaranteed for the rest of your life, providing certainty when it comes to budgeting. Your dependents could more than recoup the money paid in premiums in the event of your death.

Remember that tax rules can change in future and their effects on you will depend on your individual circumstances.

So, what to do?

Though low interest rates create challenges, they’re not insurmountable. By expanding your portfolio to incorporate a mix of asset classes with the potential for higher returns (and risk as appropriate), as well as insurance policies, you may be able to increase your ability to meet your financial goals.

There’s now greater flexibility and freedom to make smart investment choices for the long term, but it can seem overwhelmingly complicated. There are exciting opportunities to be found, and with support and advice to guide you through the investment maze, these can be harnessed.


MSCI World Index

Year to Return
October 16 27.99%
October 15 5.43%
October 14 9.13%
October 13 26.12%
October 12 9.66%

Past performance is not a reliable indicator of future performance.

1 Government Bonds and Gilts: record low yields, record high returns
2 ISC census and annual report 2016 [PDF, 1.95MB] and Revealed: the spiralling cost of private education in the UK
3 Consumer Price Inflation: Mar 2016
4 Barclays. See MSCI World Index above.
5 Barclays. Data sourced from Bloomberg. Does not include fees or taxes.
6 Barclays. Data sourced from Bloomberg. Does not include fees or taxes.
7 Barclays.

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