The so-called “cost of living crisis” is never out of the news at the moment, with the hike in energy prices, petrol, and food costs causing concern for many. Headline UK Consumer Price inflation rates have now exceeded 6% per annum, and with expectations that annual inflation could reach double digits by the autumn, many are considering how to give their income a welcome boost.
Feeling the squeeze
One group in particular who are likely to feel the effect of the price hikes more than others are retired individuals, where income levels are not keeping up with the general rising prices. The reference point that sets the annual increase in State Pension is the rate of inflation at the September preceding the end of the tax year, and as a result, the State Pension has only increased by 3.1% this year, lagging behind the current rate of inflation by some margin.
Retired individuals who hold savings on cash deposit have had to live with low interest rates for more than a decade, so in some respects conditions at the moment represent the status quo. However, the big difference this year to previous years is the fact that the gap between savings rates and inflation has widened, and this trend is only likely to strengthen during the remainder of the year.
The quest for better rates
A simple option for those who are receiving a disappointing rate of interest on their savings is to look to move funds to an account paying a better rate. The Bank of England have increased base interest rates on three occasions since December last year, and in an attempt to tackle the persistent higher rates of inflation, are likely to increase rates further during the remainder of this year. Our current expectations is that the Bank of England will hike rates a further three times before the end of the year, although the continued uncertainty over the price hikes and growth could see the Bank take a more aggressive stance if necessary.
That being said, the pursuit of improved cash interest rates remains an exercise in frustration, despite the likelihood of cash interest rates offered by banks and building societies improving during the course of year. As much as cash savings rates improve, the prevailing rate of inflation is likely to have risen further, maintaining and even increasing the difference between the cost of living and savings rates.
Look to alternative options
So what can investors do to generate much needed income and also aim to add some growth into the mix to offset the rising prices?
By considering alternative assets to cash, such as fixed interest securities and equities, more attractive levels of income can be generated. Naturally, moving away from cash deposits introduces investment risk, which is not present when holding cash (although as we have shown above, cash is not risk-free, as inflation risk can be significant). Investment risk can be mitigated in a number of different ways. By holding a diversified portfolio, with allocations to different assets that look to balance out assets that have potential for greater returns, with those that offer more predictable returns. In addition, stock specific risk can be avoided by investing in pooled funds (such as Unit Trusts or Open Ended Investment Companies) that spread the investment across a wide range of different individual positions.
Let’s take a look at those alternative asset classes in more detail. Corporate bonds, government bonds, and other fixed interest securities are loans, where the investor lends capital to the issuing company or government. In exchange, the bond provides a regular income for a fixed period of time, with a set return of capital offered when the bond redeems. These investments tend to be more predictable than equities (company shares) but they do still carry risks. These risks include default risk, where the issuer of the bond is financially unable to repay the capital or interest. This risk can be minimised by careful selection of who to lend your money to.
Dividend income generated from equities (company shares) are regular distributions of capital to shareholders. The ability of a company to pay dividends relies on the company having sufficient capital to make the distribution, and are not fixed. Dividend yields came under significant pressure during the early stages of the pandemic, but more recently, dividend yields have improved. Unlike fixed interest securities, equities tend to be more volatile in terms of their capital value, which shows greater fluctuations over time. That being said, equities have greater potential to provide capital returns, and once again, with careful management, the risks can be managed through diversification into assets held in different sectors of the economy and geographic locations.
It’s all in the blend
By blending these assets classes, together with other assets that complement the overall strategy (such as infrastructure or property) cash savings could be better employed to generate more attractive levels of income and over the longer term, aim to provide some capital appreciation. Holding these assets in an individual savings account (ISA) can enable a tax-free income to be generated and this is often a sensible way of generating additional income, particularly for those who rely on fixed incomes, such as in retirement.
Moving away from cash and into investments such as fixed interest securities and equities can be a big step and this is where expert financial planning advice can add significant value. The advisers at FAS can provide impartial advice on the options open to you and construct a discretionary managed or advisory portfolio designed to meet your income needs.
If you are looking to make cash worker hard for you, then please get in touch with our experienced financial planners here.
The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.