With interest rates falling to zero, and stock markets on the rebound, now is the time to invest in mutual funds, says investment management consultant MATTHEW FEARGRIEVE.
With governments and central banks around the world scrambling to limit the economic damage being caused by COVID-19 lockdowns, investors and savers worldwide are faced with the prospect of negative interest rates. In the United Kingdom, the Bank of England has refused rule out negative interest rates, which in theory is a move designed to stimulate the economy. the Bank's monetary policy committee has decided to stick for the time being with a base rate of 0.1 per cent, but a further rate cut to zero or lower cannot be ruled out.
The idea behind negative rates is to get money flowing out of banks and into the economy in the form of loans and mortgages. Negative rates should encourage borrowing, while discouraging savings
The prospect of negative rates should provide a further, final impetus for savers to reconsider hoarding all their spare cash in bank accounts that provide negligible or nil rewards and instead invest their money in stocks and shares.
So what should savers do to counter the rewardless, close-to-zero interest rate environment that we currently find ourselves in?
Don't worry about whether interest rates turn negative or not
The Bank of England has already asked banks to report on their 'operational readiness' to deal with zero or negative interest rates. But there are differences of opinion as to whether negative rate will actually help the economy. Andrew Bailey, Governor of the Bank of England, has indicated that the Bank is still considering whether or not to impose negative rates.
However, you should not worry a great deal about whether rates go negative or not. The fact of life at the moment is that rates are close to zero, and will not work their way upwards for some time to come. And so savers might as well act now.
If you are holding large cash reserves, you should take the opportunity now to consider investing more. Think carefully about whether you have the right balance between cash savings and investments, and consider funnelling some cash that you are not likely to need over the medium term into investments that have the potential to deliver better returns than the pathetic rates of interest that the banks are offering.
These investments can include corporate bonds, index-linked bonds, absolute return funds, real assets such as gold and infrastructure, and equities (also known as shares). We consider some of these investment products below.
Research how markets are reacting to low or negative rates
If interest rates do turn negative, it would affect the value of assets in different ways. Holding cash would earn little reward and there is even a chance savers may have to pay to keep cash in the bank. Also, if negative rates drove down yields on Government bonds, investors might be tempted to seek riskier assets in the hope of a better return.
Jason Hollands, a director at wealth manager Tilney, says those in search of a real return (one above inflation) from their savings would be 'pushed up the risk curve into corporate bonds and equities'. But he warns that the value of such assets would not be guaranteed and would fluctuate.
McDermott also says negative rates would be a 'positive' for the value of gold. He says: 'Gold is a much safer store of value than cash at this point. Also, negative interest rates would mitigate the Achilles heel of gold – namely its inability to earn interest or produce an income. Suddenly a major disadvantage becomes an asset.'
Research the investment funds that will benefit
Having weighed up how negative rates might impact your investment portfolio, the next step is to ensure you have the right investment funds.
Investment funds (also called mutual funds) are collective investment vehicles which pool investors' money and then invest that money in stocks, shares and other financial products. Equity funds invest in stocks and shares (which are really the same thing) whilst bond funds invest in debt instruments that can be issued either by governments (gilts) or by companies (corporate bonds). There are other investment funds that invest in other things; for example, commodities like silver and gold, or alternative assets like Bitcoin and other cryptocurrencies.
Some investment funds are riskier than others, and some are more expensive than others; remember that the manager of the fund will charge you an annual fee for managing the portfolio on your behalf. Your aim, in general, should be to invest in fund that delivers an index-beating or index-tracking return at a reasonable cost.
So your objective should be to identify fund managers who have delivered returns that have beaten or at least tracked the markets over the previous five year, with investment products that have an OCF (the "ongoing charges figure": broadly speaking the annual fee you pay the manager) of less than 1.00% per year (we think that any fee greater than 1.00% per year is too high). We divide them into two groups: actively managed investments and passive investments (index trackers). Actively managed funds charge you higher fees, often around 1.00% a year or more. Passive funds track a given index, and so their fees are lower.
You can read more about how to select investment funds here.
A good idea is to start with five investment funds offering good exposure to regions and also different types of funds.
A global tracker or index fund offers geographical exposure at a competitive cost. A technology fund taps into the rise of tech titans, while an emerging markets fund gives you access to the growth in emerging economies.
You might also want a little exposure to a healthcare or biotech fund to back efforts to prevent a repeat of Covid-19. And a small exposure to a gold fund is a good hedge against inflation and volatility. You might even view Bitcoin as a safe-haven asset for 2021. You can read about gold and cryptocurrencies as safe-haven assets in our blog here.
UK Shares are Cheap
UK stocks are cheap, so this a good time to invest. UK businesses are undervalued, and have a lot to offer.
The UK also has strong areas of growth, such as renewables. We have a big natural resource in offshore wind which is set to surge.
But you will need to be quick. Economic stabilisers are on the horizon, like the covid vaccine and Brexit certainty, and these will hike the price of UK bluechip companies in the medium-term. You can read more about investing in the shares of UK companies in our blog here.
Act your Age!
An important rule of thumb is that the older you are, the more you should put into safer assets (bonds). Younger people can afford to take more risk and have more invested in riskier assets (shares, also known as equities).
For example, a 60 year old would have 60 per cent in bonds, 40 per cent in shares, and a 30 year old would have 30 per cent in bonds, 70 per cent in shares.
Bear in mind also that you may well already be an investor without knowing it, if you have investments via a workplace pension. Through this investment you, and your employer, will be putting money each month into investment funds, which in turn invest in companies listed on stock markets.
It may seem boring, but it is important to spend a Sunday afternoon taking time to find out how much you have invested in your workplace pension scheme and crucially, the investment funds in which it is invested. With a little research, you may find that you are not overly impressed with the performance or the fees being charged by these funds; or both. Then you might wish to use fund supermarkets, like Fidelity or Hargreaves Lansdown, to pick your own investment fund and move your pension money into those.
Keep it Simple
Don't over-complicate things, or get too ambitious. While you might hear stories of the dramatic profits people have made from buying bitcoin, or day trading, these are complex and risky and, chances are, they don't crow too much about their losses.
Read up about the investments you're interested in and never buy anything you don't understand.
MATTHEW FEARGRIEVE is an investment management consultant. You can read his blog here and his Twitter feed here.
