What do low interest rates mean for how you structure your wealth?
What do low interest rates mean for how you structure your wealth?
Our interest rate outlook suggests that, over the medium-term, we could be facing a period of returns slightly lower than our long-term base case – making it more challenging to stay ahead of inflation. What this means for you will depend on the usual factors we consider when developing a financial plan, including your time horizon and objectives. There are three key areas to think about.
1. Managing risk
Investment risk can take a variety of forms. Most obviously, there is the risk of seeing the value of your capital decline. But the risk of investments not keeping pace with inflation – and losing value in real terms – should not be underestimated. The latter risk is perhaps greatest for more cautious investors, who could see a larger share of their return undermined in a lower interest rate environment. A pre-disposition towards “safer” assets such as government bonds, rather than higher risk assets such as equities, arguably makes their portfolios more vulnerable to inflation. Based on the current outlook, inflation will inflict a loss of purchasing power on a bond portfolio in a relatively short period of time. For example, a UK five-year gilt currently offers an annualised return of under 0.5% – compared to market expectations of UK inflation above 2% over the next five years.
Over the longer-term, of course, inflation can be far more damaging. One well known example is the 1992 legal case of Nestle Vs Natwest Bank. At issue was a portfolio that had been invested entirely in low-risk bonds since the early 1920s in order to “protect the capital interest” of the longer-term beneficiaries. The real value of the fund was drastically eroded by inflation. It may appear counter-intuitive, but a low-risk portfolio can in fact pose more risk to lifestyle in the long term than an apparently riskier one.
2. Structuring your wealth for a “total return”
Where investors are able to tolerate a sufficient level of investment risk, we advocate a total return approach, targeting attractive returns from a combination of capital growth and income. Placing constraints on a portfolio by requiring a minimum level of yield can reduce the overall return. Where a regular drawdown from the portfolio is required to support lifestyle, we would recommend it be funded using this combination of capital appreciation and yield.
A total return approach provides us with the flexibility to take advantage of the themes outlined above, many of which we would expect to generate a greater share of returns from capital appreciation. Fast-growing technology companies, for instance, will always tend to prioritise investing in their businesses over returning capital to shareholders through a dividend. A total return approach also provides us with more flexibility to invest in diversifying assets, such as gold, which may offer no income at all.
Depending on the structure in which investments are held, this approach could have tax implications. For UK investors, pensions and ISAs are agnostic about the form the return takes as neither trading gains, dividends or interest payments are subject to tax within the ‘wrapper’. Distributions are taxed (or not) under rules governing that particular structure.
Even in a taxable environment, there are still tax-efficient options. For example, our range of Portfolio Funds, where a fully diversified portfolio of investments is held within a single fund, can provide valuable tax deferral as trading gains are not subject to tax until fund units are actually sold. This “gross roll-up” helps boost returns over the long-term. Income is still taxable when it is distributed, usually in the form of a dividend.
3. Thinking about borrowing
Today’s low interest rate environment could be an opportunity to assess the role of debt within the overall structure of your assets. We would never advocate taking on more debt than can be comfortably supported by your earnings and assets. However, if debt is accessible at low cost and on attractive terms, it can provide you with additional lifestyle flexibility and be used to enhance the overall returns on your assets.
It can also play a useful role in long-term estate planning, although care is required to not unwittingly create “associated transactions” which could nullify the inheritance tax benefit of any planning work. For example, in 2015, new legislation was introduced to prevent the use of loans to purchase Business Relief (BR) qualifying investments – such as AIM shares. Previously, these provided a double IHT benefit, with the loan counting as a deduction against the estate and the BR asset qualifying for IHT exemption. The new legislation offsets the associated loan against the value of an IHT-qualifying asset, nullifying the additional advantage. However, using debt to provide liquidity for gifts and/or large purchases, can still function well, eliminating the need to draw down on an investment portfolio for capital.
Managing wealth in an age of low interest rates
Markets are worried about the return of inflation and, in turn, higher interest rates. Unlike some, we believe low rates will remain a defining feature of markets in the years ahead. This has important implications when it comes to investing, and structuring, your wealth.
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This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.