Low Risk Income in a Low Interest Environment.

By Phil Mason

So, you’ve built up a large sum of cash but don’t know what to do with it? You need an income but are uncomfortable with taking too much risk? Here’s an idea for an investment, buy a negative yielding bond, invest £100,000 and get back £98,000…

No, you didn’t read that wrong, lend £100,000, get back £98,000. ‘Why on earth would anyone do that’ I hear you ask. Well, it may surprise you to know that investors around the world are falling over themselves to get a piece of the action. So much so that as of 21st June 2019, there is estimated to be approximately $13 trillion of negative yielding bonds issued by governments and corporates globally. (1)

There are typically 3 reasons why someone would buy a negative yielding bond. The first being the complex and risky world of currency trading where investors believe they can offset the negative interest rate against a rise in a specific currency. The second reason is large investors like central banks and pension funds that have to own or purchase bonds as part of their liquidity and low risk mandate, even if those bonds have a negative yield.

The third reason is more relevant, some investors feel the negative interest rate on bonds is less than they would lose elsewhere. For example, if the negative yield on a bond is -0.1% but a bank charges 0.2% to hold cash, then the negative yielding bond would lose less versus the charges of a bank. Another example could be if an investor feels markets are about to crash, they may find a -0.1% negative yielding bond more palatable than a -10% drop in the stock market.

However, if you are not in the business of guaranteed losses, then there are other options available. Banks and building societies will offer you Cash ISA’s with rates ranging up to around 2.5% per year. But the higher rates generally mean the longer you have to lock your money up for, with some offers meaning your money is tied up for a maximum of 5 years, with penalties for accessing any of it. This is obviously not ideal when sourcing an income. The other down side is that ISA’s have an annual cap on how much you can invest, as of the 2019/2020 tax year this is £20,000 per year, which an investor may feel is far too low if they are looking to generate an annual income to live on in retirement.

Retirement is arguably the most important phase of an investor’s life. That moment when your monthly salary stops, and you have no income other than the pensions and investments that you have accumulated throughout your working life. What if you spend too much too soon? What if you run out of money before you die? What if you don’t have enough to live on? It can be quite a daunting experience.

Going back to the turn of the century, generating an income from the relatively risk-free world of cash was quite easy. However, since the financial crisis recession of 2008-2009, getting a return from cash is far more difficult. The graph below highlights just how drastic the change in interest rates has been:


GBP (LHS); % change year on year (RHS)

Source: Bloomberg, ONS, J.P. Morgan Asset Management.

That’s an interest rate of 6% in 2007, compared to just 0.85% in 2019, or another way of looking at is in 2007, a pension pot of £250,000 would have generated £15,000 (6%) of income for the year, in 2019, a pension pot of £250,000 would generate just £2,150 (0.85%) for the year.

In today’s low interest rate environment, it is generally accepted that you need to take more risk in order to generate a sufficient amount of income in retirement, and this is where the help of a financial adviser can make a difference.

At Prosperity, we understand that you can’t get away from having to take a bit more risk to earn a higher income than is available on cash and government bonds. But by fully understanding your goals and objectives for retirement and by completing an accurate risk profile, it allows us to select suitable and sustainable investments. We understand and believe that having a globally diversified portfolio, a longer-term time horizon, actively selecting the reliable income payers and diversifying across different companies and asset classes, we can reduce the risks involved and increase the income from your savings. If you are concerned that you are holding too much cash that isn’t working for you or are about to retire and take an income, come and see us for a free, no obligation chat to see if we can help.

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