Your ‘lower risk’ options assessed
As part of my day job I’m often asked to help readers of national newspapers come up with ideas for how to invest their hard-earned cash.
One such question landed on my desk from Times reader Julie recently. In brief, Julie had spent the past 26 years working and living in Hong Kong and Singapore, but planned to retire in the UK in about two years’ time.
She had over £1m sat in a deposit account which she wanted to invest, but had one red line: ‘I’m not prepared to risk the stock market.’
This is not atypical – after all, an investment that delivers inflation-busting returns with no downside risk is the Holy Grail. Unfortunately, just like the fabled goblet of eternal life, there is no evidence it actually exists.
But what are the pros and cons of holding money in supposedly ‘risk-free’ investments? And what options are available for savers pre and post-retirement who want to generate a guaranteed income?
THE ILLUSION OF SAFETY
If, like Julie, you have decided investment risk is not for you, you need to be aware of the long-term impact this could have on your savings.
Holding large sums of money in cash investments or a deposit account paying little or no interest might seem like a ‘safe’ option, but in doing so you risk seeing your spending power eroded over time by inflation.
Take someone who inherits £10,000 and shoves it straight in their instant access bank account. Assuming that money earns 0% interest and inflation runs at the Bank of England’s target of 2%, in a year’s time it will be worth £9,800 in real terms.
After five years the fund’s real value would have dropped by almost £1,000 to £9,039, while in 10 years it would be worth just £8,171. Fail to do anything with the money for 20 years and they’d have lost well over £3,000 in real terms.
Combating the deleterious impact of inflation is one of the main arguments in favour of taking at least some investment risk, particularly over the long-term where you are more able to ride out the ebbs and flows of the stock market.
However, if like Julie you remain determined not to take any investment risk, there are options available which can at least go some way to protecting your wealth from rising prices.
NATIONAL SAVINGS & INVESTMENT BONDS
NS&I bonds, which are backed by the Treasury and 100% guaranteed, could be worth considering for those who’d rather not invest in stocks and shares.
They have a range of products paying 0.8% to 1.95%, although each has slightly different terms and conditions you’ll need to consider.
You can find out more information here.
BANK AND BUILDING SOCIETY BONDS
You can also get around 2% interest on two-year deposits from several banks and building societies. While that’s not inflation-beating, it should at least minimise the damage caused by rising prices.
New offers become available all the time, so it’s worth checking websites like MoneySavingExpert to make sure you’re getting the best possible deal.
Each bank is backed by the Financial Services Compensation Scheme (FSCS), meaning your money is guaranteed up to £85,000.
To maximise your compensation, think about spreading your funds around various institutions rather than just putting it all with a single company.
Remember that some banks have multiple brands which could affect your compensation entitlement. If you have money invested through two brands that sit under the same umbrella institution, you’ll only be covered up to £85,000.
When it comes to generating a retirement income, for those who don’t want to take any investment risk at all the most likely avenue is an annuity.
Before committing to an annuity – an insured product which provides a guaranteed income for life – you should figure out how much money you’re going to need to cover your costs in retirement. Remember that once you’ve bought an annuity, there is no going back.
If you’re buying an annuity from funds invested in a pension then 25% of your money will be available as tax-free cash if you choose to take it, with the rest taxed in the same way as income.
If you want to buy an annuity out of non-pension funds – for example because you have saved in a deposit account or an ISA - you would likely need a ‘purchased life annuity’.
These are similar to traditional annuities in that they can provide a guaranteed income for life, although they are treated slightly differently for tax purposes, with a portion of your fund (the deemed return of capital) tax-free and the rest subject to tax. The amount that is tax-free will depend on your life expectancy.
Purchased life annuities aren’t simple products, so I’d strongly urge you to speak to a regulated financial adviser beforehand if you’re going down this route. Indeed, some insurers may insist on this.
If you do decide to buy an annuity with all or part of your retirement savings, it’s vital you research all the available providers and make sure you tell your insurer about any health conditions you have or lifestyle choices which could affect your life expectancy.
A regulated financial adviser or annuity broker can help you do this, although they will charge a fee (or sometimes commission in the case of brokers) for their services.
If you’re a regular smoker, for example, the insurer should pay you a higher income because they think your life expectancy will be lower.
You should also consider getting inflation protection so your spending power is preserved over your retirement.