Kate Rogers: With interest rates low, should you take risks?

If economists' forecasts are to be believed there could be weakness ahead, so how low can rates go, asks our columnist

Kate Rogers
Kate Rogers

In August, after the European Union referendum result, the Bank of England cut interest rates to a historic low of 0.25 per cent in the hope that the economy, asset prices and sentiment would be shielded from any Brexit hangover. It appears to have worked so far, according to markets, but if economists' forecasts are to be believed, there could be weakness ahead. So how low can they go?

It is sobering to consider that there are already a number of European central banks (Switzerland, Denmark and Sweden) whose rates are negative - in these countries it actually costs banks to deposit with them. In most cases, banks have not passed these costs on to depositors in the form of negative rates on savings. However, banks are far more likely to begin to charge account fees to maintain their margins.

What does this mean for a charity with cash in the bank? You have probably already seen your deposit rates fall and are struggling to find banks that pay you very much interest at all. To add insult to injury, if these cash balances persist for very long you are likely to see them eroded by inflation.

And inflation is rising. Increasing commodity prices and a weak pound mean imports are getting dearer. Retail price inflation is expected to average 3 per cent per annum over the next five years, so you're likely to be able to buy 10 per cent less with your money in five years.

What are the alternatives? You could lend your cash to the government for 10 years by buying a government bond, and get 0.75 per cent a year. But this doesn't help with inflation erosion, and you're accepting that the price of the bond can go up and down - more risk for not much more return.

You can still find income in both equity and property markets. Charity-specific property funds are likely to give you an annual income in the region of 6 per cent. Equity income funds for charities generate yields of about 4 per cent a year. Both figures are a multiple of what is achievable from cash deposits or in bond markets.

But these asset classes come with health warnings. Investments in equities or property should be done only with cash the charity is unlikely to need for at least five years. Trustees must also be prepared for the inevitable ups and downs in the value of their equity and property investments. If you can cope with these oscillations, you can hope for both attractive income and inflation protection in the long term.

The right approach for your charity's assets will depend on your ability to take risk. The price of safety in this low interest-rate environment is the erosion of your cash by inflation. The price of a 4 per cent income - the rate we used to get on our cash balances - is a more volatile capital value. It's not an easy decision, and one that deserves careful strategic thought.

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