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Why you should invest your cash despite higher deposit account savings rates

Periods of high inflation, as seen in many major nations over the last two years, often result in rising interest rates. Governments, and their central banks, use base interest rates to try to encourage saving and to remove liquidity out of the economy as a method of slowing inflation.

This is done by:

  • Making the interest rates on savings accounts more attractive, encouraging people to save and curb their spending
  • Increasing the costs associated with lines of credit and ongoing debt, which reduce people’s disposable income and company’s profit margins. People spend less, and companies tend to invest less or reduce costs. As a result, demand for goods and services falls.

Inflation measures the rise in prices for goods and services over time, which in turn follow the rules of supply and demand. A drop in demand will likely see inflation slow (disinflation) and ideally, prices fall (deflation).

The Hong Kong Monetary Authority (HKMA) announced on 27 July 2023 that it had raised its base rate to 5.75%. Meanwhile, in the UK, the Bank of England (BoE) raised its respective base rate to 5% on 22 June 2023.

So, if deposit account savings rates are on the rise, why is it important that you consider investing your surplus funds?

Investing typically produces greater returns over the medium to long term than savings accounts can achieve. It can help your money stay ahead of inflation and produce the kind of growth needed to reach your long-term goals.

Read on to discover why investing could be a better home for your surplus cash.

Portfolios are made up of multiple asset classes: cash, bonds, and equities

Saving rates for cash are pretty attractive in both Hong Kong and the UK at the moment.

According to MoneySmart, although the average interest rate of savings accounts in Hong Kong is only 0.001%, there are many high interest savings accounts offering rates as high as 4.8%, such as the Citibank Plus Savings Account.

Meanwhile, in the UK, Moneyfacts reports on the best saving rates, which it updates daily. As of 21 July 2023, the best rate for an easy access savings account is 4.65%.

Longer-term fixed-rate accounts, or those with minimum deposits, can offer even higher rates in both countries.

Yet, while savings rates are very attractive, they are unlikely to produce the same kind of growth that can be achieved by investing over the medium and long term.

It’s generally wise to set aside cash in an emergency fund to account for between three- and six-months’ worth of essential bills, such as rent, utilities, and groceries.

Having money readily available in the event of something unexpected disrupting your income and expenditure can provide welcome reassurance and peace of mind.

However, saving cash in excess of this emergency fund or money earmarked for short-term expenditure may mean your cash is losing spending power.

As a result, investing may be key to staving off the negative effects of inflation on your cash.

Bond yields benefit from rising interest rates

The market value of bonds are affected by the rules of supply and demand. As such a bond’s price can fluctuate.

The three main factors that might affect a bond’s price are:

  1. Its yield
  2. Its rating
  3. Wider interest rates.

A bond’s price typically reflects the value of the yield left within the bond. A bond with a yield of 3% will likely have a lower price than a bond yielding 5%.

Changes in interest rates can affect bond prices and these yields.

Higher interest rates typically lead to decreases in the price of bonds. Additionally, bonds with a longer maturity can see an even greater price drop. Conversely, if interest rates drop, bond prices typically increase.

This presents an opportunity for investors to acquire bonds at a lower price than usual and benefit when interest rates eventually level off and begin to drop, and the price of bonds goes up.

Simply put, when interest rates are rising, new bonds will pay higher interest rates too, and as old bonds’ yields become less attractive, they tend to drop in price.

So, the capital appreciation on bonds tends to start as and when interest rates peak and then start to reduce, which may be desirable for investors looking to generate gains.

Additionally, let’s not forget that bonds also pay an income into your portfolio, often at rates higher than cash deposits.

Rising interest rates can lead to short-term volatility in the markets, which might present opportunities

Companies, like people, are affected by rising interest rates, especially if they are particularly dependent on consumer spending habits.

Rising interest rates are likely to drive down spending, which can see a company’s stock price fall due to less products or services being sold.

It can also present other difficulties for firms, such as increasing the cost of debts and making financing harder to come by. These can have a further negative effect on their market value, as this squeezes their profit margins.

Let’s not forget, this is what the Central Banks are trying to achieve, so companies cannot keep offering their staff high pay rises. Pay rises tend to fuel core inflation.

This is when we see market sell offs, as we did throughout 2022.

At first glance, this might be worrying for investors. But volatility can also produce opportunity.

A reduction in the stock prices could see you acquire them or increase your current holding at a lower cost than usual. So, when markets come back – which history shows they typically do – the value of your investment will increase and produce favourable returns.

As billionaire investor, Warren Buffett, put it in 2016 when referring to market slumps: “When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons”.

Medium to long-term investing could produce returns greater than inflation

Over medium to long-term periods, history has shown that equity investing usually produce the kind of growth that mitigates the effects of inflation on your wealth.

Invest for long enough and the returns could outperform not only inflation, but also the higher interest rates you can currently achieve through a deposit savings account.

The graph below displays the average “real” (i.e. net of inflation) returns when investing equities during periods of high inflation:

Source: FTG Portfolios

The graph uses data from NYSE, AMEX & NASDAQ stocks in years in which inflation was high.

Many of the assets shown match or beat the best savings rates available today – while the best returns are significantly better.

We see this now with indexes showing double digit returns in the year to date. This is typical once the short-term period of increased volatility has passed.

Meanwhile, equities, like bonds, also pay an income or dividend into your portfolio. The potential for compound returns over time through reinvesting potential dividends can make investing even more desirable.

FTG Portfolios looked at potential compounded annual returns in the US between 1926 and 2021 if you had invested $1 on 31 December 1925.

If $1 had been invested in small company stocks it would be worth $56,034 in 2021, as shown by the graph below:

Source: FTG Portfolios

The potential for positive returns while investing isn’t exclusive to the US market. In the UK, IG reports that average annualised total returns for investors in the FTSE 100 – the UK’s leading stock index – between 1984 and 2022 were 7.48%.

So, over the medium term, gains experienced in a diversified portfolio including cash, bonds and equities are likely to be greater than any potential interest produced on deposit savings accounts. While, history is no guarantee of future performance, it can offer valuable guidance.

It is important to get the right advice for your personal circumstances, savings, and investments.

Get in touch

Working with a professional financial planner can help you build a diversified portfolio aligned with your own tolerance for risk and designed to give you the foundations needed to protect you from short-term instability.

If you’d like to discuss how investing in the current market might benefit your plans, you should email us at info@bmpwealth.com or call +852 3975 2878.

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