Investing to Protect Wealth
What could be achieved with £100,000?
Recent weeks have been marked by significant economic turmoil. The normal operations of UK and international markets have been disrupted by high inflation, the post-pandemic recovery period, the war in Ukraine and exceptionally high energy costs. And that’s to say nothing of Britain’s own political and financial challenges.
Given such unusual conditions, it isn’t really surprising that we have seen fallout in numerous markets. Share prices have fallen dramatically in recent months, the value of sterling fell, and many forecasters are now predicting that the UK will fall into recession in 2023.
No one would doubt that these are difficult times but, regardless of the cause, ordinary Britons must be ready to ask themselves what plans they could make to help to protect the value of their savings. In this post, we’ll explore that question, working with a hypothetical pot of £100,000 and seeing what might be achieved with it.
Savings Accounts
We’ll start with the most obvious. Savings accounts come in many different packages but they all run on the same principle. It might be an unusual way to look at it but, in essence, they all take the form of a loan – i.e. from the saver to the bank/building society. In return for that loan, the bank agrees to pay interest to the saver, according to either a fixed or variable rate.
Money that’s placed into a savings account is generally very safe – partly because well-known financial institutions tend to be regarded as secure and reliable. Very rarely is there a scare – such as the near-collapse of Northern Rock in 2008 – but even in the event of insolvency, savings are usually safeguarded. If a bank or building society is covered by the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA), then the first £85,000 of any savings held there will be protected under the Financial Services Compensation Scheme (FSCS). Consequently, savings accounts are commonly considered to be just about the safest form of investment there is.
The problem is that, for years now, savings accounts have been paying very low rates of interest. While the base rate hovered around historic lows, it was hard to find a savings account paying much more than 1.5%. However, that has changed in recent months as a consequence of seven successive hikes in the base rate.
At the time of writing, the base rate stands at 2.25% and a further increase is widely expected in November. As a result, some of the most competitive fixed rate savings accounts (typically one to three-year bonds) are now offering interest rates of over 4.5%. By recent historical standards, those rates are high, but here’s the crucial point: so too is the rate of inflation.
The latest figures from ONS put the Consumer Prices Index measure of inflation at +9.9%. Its Retail Prices Index is even higher, at +12.3%. As any experienced investor knows, inflation erodes the real value of any returns, and by ‘real value’ we mean what a given amount of money can actually buy.
We can show this with an example. Let’s say that at the start of a year, we invest our hypothetical £100,000 in a building society and it’s offering 4.5% interest on a fixed rate one-year bond. At the end of the year, we would expect a return of £4,500 plus our original investment – so a total of £104,500.
(For the sake of simplicity, we’ll pretend that this is all held in a tax-free ISA so that we can ignore the question of taxation for now. However, it’s worth briefly noting that tax is normally payable by basic rate taxpayers on any interest earned after the first £1,000. In this example, since we’re talking about making considerably more interest than that, we could certainly be facing a hefty tax bill that would reduce our overall returns.)
But to return to our simplified example, let’s imagine that it’s all tax-free for some reason and we’ve seen the value of our savings rise to £104,500 in one year. That’s moving things in the right direction. However, over the same period, the prices of ordinary goods and services have also gone up, which means that the real buying power of our savings has been reduced.
In recent weeks, CPI inflation has been running at close to +10%, and it may continue around the same level for some months. So let’s feed that 10% figure into our example. Now, in order to retain our real-terms buying power, we’d need our savings to grow to £110,000 – not to the £104,500 that we actually achieved. In short, our savings have lost value. In terms of buying power, we’re ending the year £5,500 down.
This has been the reality that savers have been facing for some considerable time now: interest rates below the level of inflation. And the consequence of that is simple: money held in savings accounts is currently losing value and, all else being equal, savers will end the year with less real value than they started.
Stocks and Shares
For most of recent history, the average returns on stocks and shares have tended to be better than the interest payable on ordinary high street savings accounts. In most cases, a well-chosen stock market investment has been far more likely to deliver inflation-beating returns.
However, no investment is 100% certain. There are risks, especially during times of economic turmoil and, in recent years, we’ve seen plenty of that: Brexit, the Covid pandemic and the war in Ukraine to name just three factors. Most recently, we also saw a decidedly adverse market reaction to the Truss government’s mini-budget in September. We won’t go into the details of those factors, but they do serve as examples of external events that can affect stock values and share prices.
In February 2020, for example, the month before the global Covid pandemic, the FTSE All-Share Index stood at just over 4,135. A month later, with businesses reeling from new lockdown measures, it had fallen to a low of 2,837. On a graph, that looks like a cliff-edge, and the drop equates to tens of billions in lost value. For those whose savings were invested primarily in stocks and shares, that would have felt like a calamitous period.
However, investment is most sensibly regarded as a long-term business, and that’s because most markets tend to recover when they return towards normal conditions. After that low point of 2,837, the All-Share Index rose to a high of 4,286 in February 2022 – higher than it had been before the first lockdown.
Since then, various factors have tended to act against business growth in the UK, so the Index has dipped again – most recently since September’s mini-budget. The peak that month was 4,108 but by 12 October, it was down to 3,712.
It’s important to recognise that the Index is effectively an average; a “capitalisation-weighted index” made up of approximately 600 companies traded on the London Stock Exchange. During these periods of ups and downs, some shares will have fared much better than others, so it would be wrong to suggest that all stock markets investments would inevitably gain value as the Index rises, or that they would all lose value as it falls. An investor who picks the right shares might still see good returns, even in the midst of a severe recession.
However, the Index does give us a broad indication of the general health of the private sector economy and so it’s useful if we’re trying to give a fair, evidence-based illustration of what return a typical stock market investment might produce. With that in mind, let’s imagine that, a year ago, we had invested £100,000 into a mixed basket of shares from the companies featured in the All-Shares Index.
In mid-October 2021, the Index stood at roughly 4,124 but 12 months later, it had dipped to 3,742. That’s a drop of just over -9.2%. Of course, stocks and shares also usually pay a regular dividend and, according to the FT (17 October), average dividends had the effect of raising the total return to +8.22% year-on-year. That’s a much more palatable result overall but in the context of inflation, it’s clear that the ‘average’ stock market investment would still have delivered a loss in real terms. Add to that the further erosive effects of inflation, and the financial results would have looked rather disappointing.
One could, of course, argue that Brexit, Covid and Russia’s invasion of Ukraine have all been extraordinary events, not typical of what normally happens in the UK economy. And certainly, that’s a conclusion that historic stock market data would seem to support.
In 2019, for example, the FTSE 100 Index (which features the top 100 companies on the London Stock Exchange by market capitalisation) ended the year +12.1% higher than the previous year. The total return that year (i.e. the value gained plus dividends) was an impressive +17.1%. Looking at a much longer period – between 1984 and 2019 – the average annual total return has been +7.8%.
In the long term, then, average returns from stocks and shares can be very solid, but the problem here is that the results can be unpredictable and volatile. While it’s true that individual events such as the global financial crisis, Brexit, the Covid pandemic and the war in Ukraine are exceptional, events of that magnitude do keep happening. And every time they do, at least some parts of the stock market will suffer.
The key point here is that the stock market encompasses businesses and commodities of all kinds; ‘the whole economic world’ if you will. Consequently, it’s virtually impossible for the average investor to develop a detailed understanding of all the available market opportunities. In short, it’s a demanding field – the province of professionals – and since mistakes can be very costly, direct self-managed investment isn’t an option that tends to suit ordinary savers and families.
Consequently, many of those who do consider stocks and shares will tend put their money into the hands of an experienced broker. The broker will charge a fee, and – as ever – inflation will erode the real-terms value of any gains, but this approach should at least help to improve the chances of investing in a higher-performing asset and to mitigate the risks of incurring significant losses. However, even professional investors struggle during times of economic upheaval – as can be shown by a glance at the values of many professionally managed pension funds this year.
Whereas savers can be sure of at least getting their money back, those who invest in stocks and shares have no such safety net. They will always stand a risk of getting back less than they originally put in. Stocks and shares may offer higher potential rewards but the risks are also proportionately higher, so they might not be the best option for savers who are relatively risk-averse and for whom security and peace of mind are as important as the chance to maximise their returns.
‘Safe Haven’ Commodities
In times of economic crisis, gold and other precious metals are often regarded as relatively safe bets for investors. The theory is that they have intrinsic value and that they tend to hold it better than stocks and shares, which may be more dependent on different companies’ commercial performance and on wider economic growth.
The problem, sadly, is that the theory doesn’t always hold. If we had invested our £100,000 in gold this time last year (October 2021) then we would have seen a disheartening downward trend since then. It would have started with a value of $1,914 per ounce, but declined to a price of just $1,655 a year later. We would have seen a -13% fall in value, and that’s before we’ve taken account of inflation.
Cryptocurrency
The lack of intrinsic value was a criticism levelled at cryptocurrency by the Bank of England last year, and despite numerous celebrity endorsements, it quickly began to display its weaknesses. Its value peaked in November 2021 but, thereafter, investors lost confidence and many well-known crypto-coins plummeted in value.
In October 2021, Bitcoin was worth $57,355. This month, it stands at $19,277 – marking a drop of over 66%. Values have barely recovered since the low point of June 2022, when many media ran stories about poorly-advised savers having “lost everything”.
In our case, had we invested our £100,000 in Bitcoin last year, we’d have seen it lose over £66,000 in value, and what remained would have been devalued by inflation. As investment options go, this would have been one of the worst.
Unusual Commodities
Some investors develop a penchant for certain niche markets and commodities, which could take the form of anything from artworks to vintage cars. Some may perform very well in certain years and some will show a generally upward long-term trend. If we look at the price of rare whiskies, for example, we see that the average price of 100 iconic collectors' bottles has risen by over +385% since December 2012. In just the 12 months to October 2022, the average value rose by +19.81%.
If we had invested £100,000 in rare whiskies last year and sold them today, then we might now be enjoying a (gross) return of £19,810. That’s an excellent result that would have been substantially higher than the CPI rate of inflation; in short, a clear real-terms gain.
Part of the challenge here is that this is very much a market for specialist investors. Just because average values rose quickly this year, it doesn’t follow that any investment in rare whisky would have delivered that same result. As with stocks and shares, a good result relies on picking exactly the right investment, and while some rare whiskies positively shot up in value, others actually fell.
The market is also rather volatile. According to the same index at the time of writing, average values had fallen by -2.47% over the course of the last month. Average values peaked in May, when the index stood at 505.85 but the index has since dropped to 481.95%. Moreover, the market has also sometimes stayed relatively static: between January 2018 and December 2019, for example, the index barely moved, starting at 310 and ending, 24 months later, slightly down at 308.
Here, again, we see the interplay of risk and reward. Some investors with interests in whisky, vintage cars, precious stones or other collectibles might enjoy great results in any given year. Others will make losses on broadly the same types of investment. Having (or hiring) specialist expertise may improve the odds of making a good return but, given the market volatility and the complexity of the subject, this is perhaps more the realm of the ‘affluent enthusiast’ rather than ordinary savers who are looking for safe but rewarding havens for their money.
Commercial Property
The concept of ‘intrinsic value’ is important to many investments. It has been exposed as a weakness of cryptocurrency and it could perhaps become an Achilles heel for other asset classes too. However, property is one asset class that has a clear intrinsic value. People needs ‘bricks and mortar’ if they are going to run many sorts of enterprise – anything from a vehicle mechanic’s repair shop to a food processing plant, or from an accountant’s office to a care home. Without the building, the business would struggle to exist.
However, this close connection between business success and commercial property values can also be a weakness. During the Covid pandemic, for example, with most of the UK going into lockdown, many offices, shops, hotels and other premises were left vacant – incurring costs without generating a revenue. This had a depressive effect on commercial property prices.
Certain commercial sectors have also been witnessing a trend away from bricks-and-mortar investment as more and more customers choose to shop online. The uncertainty surrounding future business models, particularly in the retail sector, coupled with rising concerns over the cost of borrowing, have led to greater caution in the market.
In June 2022, for example, Savills wrote that “the market is entering a period of navel-gazing as investors take stock and wait for evidence of market pricing. The sudden and dramatic change in sentiment is reflected in the investment volume numbers… monthly volumes have been trending downward since the start of the year with just £8.3 billion transacted in Q2, the lowest level since Q2 2020 during the height of lockdown restrictions. Pre-Covid, you have to go back to 2012 for a lower quarterly investment volume.”
It's difficult to give a meaningful figure for ‘average’ price changes in the commercial property market because the term itself covers such a range of building types. In any given month, industrial and logistics buildings might see price rises, while the average value of retail and/or commercial offices might fall. However, the agency Carter Jonas has analysed data from MSCI, and concludes that “over the three months to August, capital growth was -3.9% for industrials, -1.0% for retail, and -0.9% for offices.”
Data from Savills shows that average growth in the value of commercial property has tended to lag behind the rate of inflation. Its graph shows this as a consistent trend that has persisted since at least 1989. It suggests that across all property types, average capital growth has been averaging less than +2% in 2022, while (RPI) inflation is averaging above +10%.
CBRE also indicates a downward trend, writing: “Capital values decreased -1.6% across all UK commercial property in August 2022... Over the month, rental value growth was +0.5%. Total returns were -1.2%.”
That reference to rental value is important, of course, because, like residential property, commercial premises deliver a monthly return as well as the possibility of capital growth. In many years, rental values have been good and, in 2022, the all-property average has been a little over 5%. In ordinary years, that might be considered respectable but, taken together with slow (or negative) capital growth, it suggests that average real-terms returns will have been poor over the last 12 months.
Looking ahead, conditions for commercial property investors could be even less promising. UK businesses already face a number of major economic challenges and there is the prospect of a recession in the coming months. Rising living costs will likely erode consumers’ willingness to spend more on leisure and non-essential shopping, so high street sales are likely to contract. Similarly, fuel and energy prices may remain extremely high and government support on these commodities is currently expected to last only 6 months.
These and other developments could put real pressure on profitability, limiting companies’ ability to buy property or pay higher rents. That could all be a recipe for a slower-moving property market and modest returns in terms of both capital and rental values.
In its Survey of Independent Forecasts for UK Commercial Property Investment, published in September 2022, the Investment Property Forum (IPF Research) wrote: “The 2022 All Property average total return has significantly declined, by almost 380bps over the quarter, to 6.4% (from 10.2% in May). The projection for 2023 is also notably weaker, falling to 3.0%, a reduction of 225bps.
“Capital value growth forecasts for 2022 and 2023 have been significantly downgraded from the previous survey. The 2022 forecast stands at 2.3% (previously 5.9%) and the 2023 forecast has turned negative, at -1.5% (down from 1.2%). …The five-year annualised forecast of 1.1% pa is weaker than the previous survey (1.8%).”
With inflation expected to be running at around 10% or 11% next year, it seems unlikely that the average commercial property investment will be capable of delivering inflation-beating returns in 2023 or, indeed, for some considerable time to come.
Residential Property
Residential property has remained a relatively safe and secure asset class for many years, primarily because it has intrinsic value and because demand consistently outweighs supply. That remains true even when the economy is on a downward trend – i.e. because people will always need places to live.
We won’t discuss residential property in detail here because it’s a subject that we have discussed a great deal in other articles. Briefly, however, it is worth noting some important factors that are underpinning the continued disparity between demand and supply and, thus, the underlying robustness of the market.
Some of those include the increasing size and average age of the UK population, the desire of many young people to remain mobile in order to chase new employment and a continuing high incidence of divorces and splits between couples – which effectively creates demand for two separate households where previously there had been just one. None of these demographic forces looks set to change any time soon.
The most obvious result of this excess of demand over supply has been an upward trend in capital and rental values. The latest house price indices from Nationwide and Halifax put the annual rate of house price growth at +9.5% and +9.9% respectively – in other words, close to the rate of CPI rate of inflation.
In addition, of course, buy-to-let property also delivers a monthly rental income and, depending on which source you prefer, average gross yields have ranged this year between about 3.5% and 4.5%. If we add take an average of the two house price indices mentioned above (equivalent to +9.7%) and add that to the mid-point of that rental yield range (equivalent to about 4%) then we see a total annual return of 13.7%.
If we had invested £100,000 in a typical buy-to-let residential property 12 months ago, that would have returned a gross figure of £113,700. The net figure would have to be reduced to take account of repair and maintenance bills and other costs, but the result is still going to be close to (or a little better than) the current rate of inflation.
Summary
Almost every figure included in these examples will be arguable, so the numbers that we’ve used can only offer a rough, averaged-out illustration of how different types of investment have performed. Even more importantly, they cannot give any reliable indication of how those same asset classes might perform in the future.
Even within a single asset-class category, the success of individual investments will vary enormously, depending on each investor’s choice. That’s true whether you’re investing in stocks, shares, residential property or some exotic rare spirit. Two similar assets might end the year with hugely different market values – and this is precisely the sort of uncertainty that lies at the heart of investors’ risks. It’s also why local market research is essential and why it’s so important to take advantage of expert professional advice.
However, the numbers we’ve used have all come from third parties, most of them well-recognised brands or authorities in their respective fields. To that extent, they are probably a fair indicator of real-world conditions and, if we accept them as the basis for a comparison, we can see how investments in different types of assets would have performed over the last 12 months.
Type Gross return 1 Real terms result 2
Typical savings account +4.5% Loss
Shares (FTSE All-Shares Index) 3 +8.2% Loss
Gold -13% Loss
Cryptocurrency (Bitcoin) -66% Loss
Rare whiskies +19.81% Gain
Commercial property (cap. gains + yield) +7% (approx.) Loss
Residential property (cap. gains + yield) +13.7% Gain
Note:
1. Year to date, as at October 2022
2. ‘Real terms result’ assumes CPI inflation of 10%
3. Average change in value + average dividend
The figures may be arguable but, in broader terms, what they certainly show is that at times of high inflation, it’s very important to think about how any money saved can be made to work harder in order to protect its real-terms value. There are economic storm clouds ahead and doing nothing clearly isn’t an option.
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