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Written by: Shaan Raithatha
12/11/2020
Few people can have failed to notice just how low a return you get on your cash savings these days. With negative interest rates a possibility, is now the time to consider investing?

Savings rates have been low for a long time, of course, but any notion that interest rates might finally head higher are now a distant memory due to Covid-19 and the emergency policy responses that have followed.

With the Bank of England’s base rate currently set at just 0.1% many people must be thinking: what’s the point of leaving my money in cash? And it’s becoming an even more pressing question now the Bank of England is considering pushing interest rates into negative territory, as has been the case in the euro area and Japan for some time.

How low could they go?

Vanguard continues to expect interest rates globally to stay low into 2021. The Bank of England announced an extra £150bn worth of quantitative easing – or bond buying – at its November meeting as it responds to a faltering economy and risks are skewed towards further easing next year.

Whether or not that also translates into negative interest rates in the UK remains to be seen. But it’s fair to say that savings rates will likely remain depressed at rock-bottom levels for longer, aggravating the dilemma many savers are facing.

Negative rates at the Bank of England would mean high street banks are charged for the reserves they keep on deposit at the central bank. Although we don’t believe this extra cost would be passed on directly to retail clients, in line with what we’ve seen in most of the other countries that have experimented with negative rates, such a development would undoubtedly bring the poor return you already get on cash into even starker relief.

And if that cash is just sitting in an investment account doing nothing you could be facing a double-whammy of not earning anything and still paying a fee.

It’s always important to have cash set aside for unexpected emergencies, especially when the economic environment is as uncertain as it is today. But above and beyond that, it’s worth considering whether your cash savings would be better invested elsewhere, such as in shares or bonds, to minimise the risk of not achieving your future goals such as having a healthy pot for retirement.

What about bond yields?

Yields on bonds, a proxy for long-term interest rates, are also depressed, weighed down by worries over the state of the global economy, disinflationary pressures, and by the effects of central bank bond buying.

So is it still worth investing in bonds? The short answer here is ‘yes’. Right now, bond yields are at rock-bottom levels. In fact, in many cases they are negative, meaning some investors are effectively paying for the privilege of lending money to some governments. As the charts below show, about a quarter of the world’s outstanding bonds are currently negative-yielding.

Chart 1 shows how bond yields have fallen substantially over the last year while chart 2 shows around 20% of global bonds are offering a negative yield:

But bond yields, which move inversely to bond prices, can go lower still because even at these expensive levels they continue to provide investors with a degree of insurance against the risk of worsening economic conditions and growing deflationary pressures.

Just as importantly, the role of bonds as investment stabilisers remains intact. For us, the primary role of bonds is not to drive returns – that’s more the job of shares, which offer more potential upside but also come with more risk. Their main job, rather, is to provide ballast in a portfolio. Since government bonds tend to behave differently to shares, they’re able to act as shock absorbers in a multi-asset investment portfolio. They can balance out the risks in a portfolio. And this remains true even in a low-yield environment, our research shows.

The potential good news is that lower rates for longer may yet justify higher valuations for riskier assets, such as shares, based on the kind of analysis that financial modellers typically use.

In general, though, we’ve been anticipating a low-return environment for some time at Vanguard. One thing we’re sure of is that there’s no easy escape: it may well be that we have no choice but to save more money for longer.

Shaan Raithatha is economist for Vanguard Europe

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