Back in October 2008, Bank of England base rates were 5 per cent.
Today, they are 0.5 per cent and have been at this level for more than five years. Prior to the financial crisis of 2008, UK investors had become accustomed to rates of between 4-6 per cent – a far cry from the double digits that were such a feature of the late 1980s and early 1990s.
It’s also important to consider inflation – in spite of the fact that many clients still insist on looking at their returns in nominal terms without regard to the rate at which prices are rising.
This gives rise to the notion of ‘real returns’, which are, quite simply, the nominal return achieved minus the prevailing rate of inflation.
If we look back over the past 25 years of interest rate and inflation data, we see that in 1990, interest rates had peaked at 15 per cent while inflation topped 8 per cent, meaning that the real return on deposits was roughly 7 per cent.
A decade later in 2000, inflation was struggling to touch 1 per cent while interest rates were still approximately 6 per cent, which would have delivered a real return of more like 5 per cent.
Today, the inflation figure is roughly 1.5 per cent, but with interest rates stuck at 0.5 per cent, the real return on cash is -1 per cent.
The issue is compounded by the high levels of debt in the UK, which make it difficult for the Bank of England to raise interest rates.
And with the outlook for the UK economy still hanging in the balance, rates aren’t expected to return to historical levels any time soon.
All this has occurred at a time when life expectancy is increasing and the UK population, like others in the western world, is ageing fast.
This in turn is leading to longer periods in retirement and an ever-increasing demand for income.
Naturally enough, this situation has created quite a challenge for those in retirement, as the traditional solutions – namely placing money on deposit or buying government bonds – offer very little, with interest rates and bond yields still at historic lows.
The solution therefore lies in them looking beyond the confines of cash and bonds and including a wider range of assets in their portfolios. But this raises the spectre of greater risk.
Considering that, generally speaking, retirees can’t replace lost savings from earnings or wait for market conditions to improve before they draw their income, the mindset of most is that they simply cannot afford to take on such risk.
But it is time to question this premise, as clearly many of those approaching retirement today can’t afford not to take on some level of additional risk.
A reasonable level of retirement income is achievable today, but it will require a sea change in the way people think.
