Cash waits to be rethroned as low interest rates hit savers

Higher inflation presents a threat to savers as money thought to be tucked safely away loses value in real terms.

The financial crisis was a rude shock to those who assumed their cash was entirely safe if they left it in the bank. Mick Tsikas / Reuters
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Once upon a time, cash was king. It sat proudly behind its battlements, promising a haven for anybody reluctant to trust their fortunes to the stock market.

But the financial crisis toppled cash from its throne. As desperate central bankers slashed interest rates to all-time lows, savers were cast out into the cold.

Five years later, savers are still naked and exposed, battling for every percentage point they can get. The king is dead. Long live, well, what exactly?

Right now, cash doesn't have just one mortal enemy, but two. Low interest rates and stubbornly high inflation present a double threat to savers, says David Hughes, the senior area manager at PIC (Middle East). "Quantitative easing remains the tool of choice for most central banks, who risk driving up inflation by massively expanding the monetary base. If you paid £10,000 [Dh59,251] into a high interest savings account five years ago, it would now be worth £8,800 in real terms. This is a palpable loss."

Given the near-impossibility of generating an inflation-beating return, cash guarantees only one thing: that the value of your money will fall in real terms, year after year.

Many savers don't realise this. They see their money sitting snugly in the bank with a little interest on top and fail to understand that this money simply isn't as valuable as it was.

Inflation is a particular threat for people planning to retire shortly, says Mr Hughes. "They should be looking to reduce their exposure to high-risk stocks and shares, and transfer their money into cash and bonds. But many are forced to remain invested in the stock market to preserve their money's purchasing power. This puts them in an unpleasant position, because they are taking on greater risk than they should at this stage in life."

This doesn't mean investors should abandon cash altogether, says James Humphreys, the senior investment manager at Duncan Lawrie Private Bank. "Cash still offers two important things. First, everybody should have a rainy day fund on instant access for financial emergencies, worth at least three to six months' salary. Second, cash is a good place to temporarily park your money while you're looking for new investment opportunities."

The banking crisis was a violent shock to anybody who assumed their cash was impregnable if they left it in the bank, especially a big, reputable and globally-renowned bank. Panicking savers in many countries formed frantic queues to demand their own money back. If governments hadn't stepped in, many would have lost everything.

Since then, governments around the world have beefed up their deposit protection schemes. But watch out, they still offer only limited protection, says Steve Gregory, a managing partner at financial services company Holborn Assets in Dubai. "In the US, the limit is $250,000 [Dh918,250], but only if the deposit taker has insurance from the Federal Deposit Insurance Corporation, and not all of them do. In the United Kingdom, protection goes up to £85,000 (Dh492,000). In the euro zone, it is €100,000 (Dh484,836). Protection in other countries varies enormously, with some offering nothing at all."

Offshore protection also varies. In Guernsey, Jersey and the Isle of Man, local deposit protection schemes only cover the first £50,000.

Typically, that compensation limit applies per banking group, even if the group has several different brands. If you were to split £100,000 between two brands from the same banking group, you would only get £50,000 total protection.

"Check local rules carefully before making significant cash deposits and spread your money over a number of accounts across different banking groups," says Mr Gregory.

There is no such thing as a risk-free investment any more, and that includes cash, says Dan Dowding, the chief executive for the Middle East and Asia at IFAs Killik & Co in Dubai. "Many people persist in viewing cash as a safe asset because you cannot suffer a capital loss, but historically it has delivered the lowest returns of all the asset classes."

Savers can fight back by constantly switching their money into the latest market-leading account, but few have the energy to sustain this policy for long.

If cash no longer cuts it, you have to look elsewhere to protect the real value of your money, says Mr Dowding.

Government and corporate bonds were traditionally the next step up from cash, paying a slightly higher return for a little extra risk. But government bond yields have plummeted lately, for example, 10-year US Treasuries yield currently less than 2 per cent.

Investors could get a better return by investing in a bond fund that offers a spread of bonds.

M&G Offshore Corporate Bond has delivered a total return of 57 per cent over the past five years, while the recently-launched JPM Global Corporate Bond and Fidelity Global Corporate Bond returned about 10 per cent over the past 12 months.

That is a far better return that you will have got on cash, but again, you have to accept a greater level of risk. If all that virtual money printing kicks off a burst of global inflation, the fixed rate of interest you get on bonds will soon look derisory. Bond prices could plunge as a result, as investors flee for the exits.

The result is that many investors have been forced to embrace even more risk by shifting their money into the stock market.

Historically, stocks and shares have outperformed inflation, and history looks likely to repeat itself, says Mr Dowding. "It is possible to build a portfolio of dividend-paying global blue chips that yields between 3 per cent and 4.5 per cent a year, with the prospect of capital growth on top."

You can create your own portfolio of direct equities by investing in high-yielding stocks such as the health companies, GlaxoSmithKline (which yields 5.1 per cent) and Merck (3.5 per cent), the US telecoms giant AT&T (5.1 per cent) or the Kleenex manufacturer Kimberly-Clark (3.1 per cent).

Or you could buy a mutual fund investing in a spread of high-yielding stocks. Mr Dowding recommends Schroder Maximiser, which has a target yield of 7 per cent and delivered a total return of 25 per cent last year.

To help you overcome short-term volatility, you should never invest in stocks and shares money that you are likely to need in the next five years or so.

Many older savers will be unwilling to return to the stock market, which means they have little choice but to endure today's less than royal returns.

With central bankers searching for new ways to stimulate their flagging economies, it could be some years before cash is declared king again and savers finally get to live happily ever after.