Savings account interest rates are dire and returns are being wiped out by inflation. Is now the time to invest in shares?
Savers are getting a kicking at the moment. Bank and building society interest rates remain at rock bottom and what little return savers are getting is being wiped out by inflation. With that in mind, is now the time to invest in the stock market?
Over the past 10 years, UK equities have significantly outperformed both cash and property, according to figures from Rathbone Unit Trust Management. They show that in the decade to 31 January 2013 the return on equities was just over 170% – an average of 17% a year. This compares with property returns of 75% over 10 years and just 38.65% for cash.
The immediate outlook for returns from savings is even worse than this. In last week’s budget, chancellor George Osborne said the Treasury and the Bank of England are considering whether to extend the Funding for Lending (FFL) scheme to further increase mortgage lending. The unintended side effect of this scheme is that banks and building societies no longer need to raise money from savers’ deposits because their coffers are swollen with all that FFL cash. As a result, significant falls in interest rates have hit almost all savings products – an extension the scheme will do little to encourage savings providers to increase them.
With inflation at 2.8%, basic rate taxpayers need to find a savings account paying at least 3.5% a year; while a higher rate taxpayer needs to find an account paying at least 4.66%. Out of the near 900 products on the market, none matches inflation and there are only five cash Isas that will generate a real return at the time of writing.
Even the government-backed savings provider National Savings & Investments says it does not anticipate being able to put its popular index-linked certificates on sale in 2013-14. This removes the faint hope that NS&I might have thrown a lifeline to desperate income-seekers – the certificates historically have paid interest equal to the RPI measure of inflation plus around 0.5%.
So is now the time to dip a toe into the stock market for the first time? Tom Stevenson, investment director at Fidelity Worldwide Investment, says the age-old dilemma of whether to invest your money in cash or shares is “relatively easy to answer this year because the rates on cash are so pitiful”.
“Four years after interest rates hit a 300-year low of 0.5%, many reluctant investors are accepting they will have to take some level of risk in order to have any chance of achieving a higher income,” Stevenson says. “If you’ve never invested in the stock market but want to do so, then now is as good a time as any.”
Decent performances from the major stock markets have tempted many first-time investors. The FTSE 100 index has risen 9% since the start of the year, while the US Dow Jones index is up 10%.
When markets have done well, many people worry that those buying in could be doing so at the top of the market, but many investment professionals claim that equity valuations are currently cheap. Conventional wisdom is that if you buy when prices are low, you have a better chance of making money over the long term. But that doesn’t mean the stock market can only go one way – markets are still likely to be volatile as a result of wider global macro-economic pressures.
For the last 18 months investors have been highly concerned with these global issues, which include a “hard landing” in China, the eurozone debt crisis, the US “fiscal cliff”, and geopolitical tensions in north Africa and the Middle East. While some readers may have to Google what these mean, it essentially boils down to the fear that events outside the control of an individual investor (and the funds the investor pumps their cash into) may lead to a perfectly reasonable investment nose-diving.
“Portfolios have been positioned accordingly,” Danny Cox of Hargreaves Lansdown says, “with investors being defensive, investing in plenty of cash and bonds waiting for one of these macro events to break out. The trouble is none has and in the meantime cash rates have continued to fall as the Funding for Lending has taken its toll on savers. That is not to say they couldn’t, but at least for the time being these risks appear to have been put to one side.”
It’s a good time to invest, tax-wise. There’s still time to use this year’s annual Isa allowance – you can invest up to £11,280 in a stocks and shares Isa, free of capital gains and income tax, before 5 April 2013. If you already have a cash Isa you can invest less.
But you must first ask yourself what it is you want to achieve by investing, how long you are planning to invest for and how much risk you are prepared to take. This will help you decide on the most appropriate mix of investments.
Cox says: “If you are willing and able to accept that your investment can go down as well as up you could consider investing in the stock market. However, you should hold back sufficient cash to cover short-term spending and provide an emergency fund.”
“It is incredibly difficult to know when it is the right time to invest,” says Patrick Connolly of independent financial adviser AWD Chase de Vere. “This is because nobody can consistently call stock markets, those who try get it wrong as often as they get it right. In the words of renowned economist JK Galbraith: ‘There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know’.”
This is why investors new to equity investing may be better off plumping for a regular monthly savings plan or drip feeding their investment (invest half now and then the other half in equal instalments over the next six months) as this can smooth returns, leading to a less bumpy ride, says Darius McDermott of adviser and broker Chelsea Financial Services.
Regular savings in falling markets allow you to buy more of the investment at lower prices, so if the market eventually regains the lost ground it will count for much more.
If the market rises you profit from the increasing value of investments already made and, providing you cash in your plan when the price is higher than the average you’ve paid, you will make money.
Money | guardian.co.uk
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