Viewing posts categorised under: Interest rates

Compound interest – The Eighth Wonder of the World

By Spectrum IFA
This article is published on: 2nd May 2017

02.05.17

Albert Einstein reportedly said it. “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

Regardless of whether Einstein uttered these exact words, the essence of his statement is still immensely powerful and cannot be disputed. For anyone who wants to build lasting wealth, understanding and harnessing the power of compound interest is essential. So, what is compound interest? Well, it is the exponential increase in the value of an investment. Or, more simply put, it is the interest that you earn on your interest.

For the more visual of you, imagine, if you will, building the bottom part of a snowman. It starts with a snowball (or initial investment). You roll it around in the snow and it slowly gets bigger (interest on the investment). A slow and monotonous process until something wonderful becomes apparent – the snowball not only gets bigger and bigger, but at a faster and faster rate (interest on the interest).

Compound interest - The Eighth Wonder of the World

Put another way, let’s say that you invest €100,000 at (just to keep the maths simple) 10% interest per year. After the first year, you would have earned €10,000 of interest, with your total investment now worth €110,000. After the second year, your 10% annual return would have earned you another €11,000, giving you a total of €121,000. Year three would see your investment rise to €133,100. Over time this growth accelerates, meaning that you would double your initial investment in approximately seven years, simply by harnessing the power of compound interest. Sounds pretty easy, yes? So, why don’t more people do it? Well, for two main reasons, in my experience:

The key requirement for generating compound interest is time – the longer you leave your money to grow, the more pronounced and positive the outcome. Modern times have encouraged us to expect immediate rewards. For many, being told that it will take a good few years to see significant returns on their investments can be demotivating.

Another common reason is “it’s a bad time right now.” In the 1970s we experienced record breaking levels of inflation, in the 1980s Black Monday brought the biggest stock market crash since the 1920s. The 1990s saw a period of sustained recession. Currently, there are many economies around the world that are still recovering from the financial crisis of 2008, almost ten years on. Yet the stock market performs over time and continues to do so. The timing of an investment is far less important than the time that is allowed for it to deliver.

Essentially, having a long term investment strategy – allowing growth to be achieved over time – provides the best possible opportunity to achieve financial security for you and your loved ones in later years. With compound interest, the old Chinese proverb holds true. “The best time to plant a tree was twenty years ago, the second best time is now.”

How can I make my money grow when interest rates are so low?

By Pauline Bowden
This article is published on: 26th April 2017

26.04.17

“Devastating, that is the effect that low interest rates have had on our income.” This quote shows that the impact of low interest rates is real, not some arbitrary number that may or may not be higher from another bank. Another recent quote from a client is “I am trying to build a pot for my retirement but interest rates will be low for the rest of my working life”.

Arguably, the person above who is still working has the chance to do something about the interest rates. For the couple from the first quote, they had been used to an income of 11,000€ pa from the interest on their bank accounts. When interest rates fell, so did their income to just 2,000€ pa. The Interbank ie base rates are minimal. You would be lucky to get 0.25% interest on a normal deposit account.

How to improve your income and investment return.

Here is a strategy that will help overcome very low interest rates. Firstly, there is no alternative to a bank account for some of your money. If you have planned expenditure then leave this money in the bank. Typically, this would be for a car, cruise or even perhaps a wedding just as some examples. Add to this an amount for an emergency fund. The amount will vary depending on your circumstances but three months of your normal expenditure is a good guideline.

Why do you need to leave money in the bank for these purposes? It is because other forms of investment often need to be allocated for the medium term. And unless you are simply lucky, money put into other investments needs to be allowed time to grow.

Are there alternatives to bank accounts? Yes, there are many alternatives. Do they work in the same manner as a bank account? No, they do not. This is why they can provide a better return on your investment. For this type of investment, do not put all your eggs in one basket. You need different types of investments (different asset classes) to give you diversification. Stick to the basics such as top quality fund management names. You do NOT need to be investing in rainforest woods, bitcoins or oil exploration companies that are about to discover hidden reserves (examples we come across regularly).

The outcome of a diversified portfolio will make a big difference to you, whether you are seeking income or capital growth. A 200,000€ investment with a return of, say, 5% would produce 10,000€ per annum. Not quite the 11,000€ that you may have been used to but certainly better than leaving it in the bank!

Every Cloud

By Derek Winsland
This article is published on: 8th September 2016

08.09.16

With the exception of a weakening pound and falling interest rates, we are yet to see the full impact of Britain’s vote to leave the European Union. Perhaps we may not ever see it if Teresa May and/or others decide against triggering Article 50 to herald the start of the process. We currently sit in a ‘phony’ period where no-one knows quite what will happen, causing doubt and uncertainty to set in. We await with bated breath the latest results to come out of the Treasury and the Bank of England.

The latter recently reduced interest rates to an historic low of 0.25%, at the same time announcing a new round of Quantitative Easing. Falling interest rates are either a good thing or a bad thing depending on which side of the saver/borrower fence you occupy. Clearly borrowers are happy, but for savers, especially those who rely upon their capital to supplement their retirement income, it’s not such a happy picture. Indeed, I am seeing this most days I speak to people about their finances. Thankfully, we are able to make investment recommendations that will generate higher levels of returns to counter falling interest rates, but these don’t suit everybody. But like most things I find in financial services, there’s generally a positive that accompanies a negative, if one looks close enough.

One such area relates to the impact falling interest rates has upon pension transfer values. In my last article I touched upon the way transfer values from occupational (defined benefit) schemes are calculated. Without going into chapter and verse, a fundamental part of the calculation process uses gilt interest rates to determine the transfer amount. Although the schemes have a certain amount of leeway in interpreting the rules, the bottom line is that low interest rates result in much higher transfer values having to be quoted by scheme trustees. This makes the decision on whether it suits an individual’s purpose to transfer somewhat easier to determine.

The observant amongst you will recall I mentioned TVAS in my last article, and the (somewhat out-of-date) rules that the FCA still clings on to. Remember critical yields? Well, a higher transfer value will result in a more achievable critical yield becoming attainable, so making the decision to move to a personal pension such as a QROPS, easier to make. Sure there are variables and these are more or less important depending on who you are and what your circumstances are. Carrying out a full analysis of your own particular situation, Spectrum’s advisers can place you in an empowered position to make your choices, so, if you have a defined benefit scheme that you’ve either never reviewed, or one that hasn’t been looked at for a while, perhaps now is the perfect time to do so.

Every cloud……!

How much have your savings increased in the last 12 months?

By John Hayward
This article is published on: 26th November 2015

26.11.15

How much have your savings increased in the last 12 months?

Which of the following reflects where your money has been?

Savings account +0.5% to 2% (before tax)*

FTSE100 -3.17% (before charges and after dividends)*

Cautious fund +4.3% to 5.5% (after charges)*

With interest rates predicted to stay low for some time to come, many in Spain are finding it difficult to grow their savings, or increase their income, without having to take risks they would not normally do, risking their capital.

So what are the options?

Deposit account
There are Spanish savings accounts offering around 2% although in reality this could be the rate for the first few months which will then reduce to a much lower rate. There are often restrictions on how much you can invest in these accounts. Inflation is running at a higher rate than most savings accounts and so, in real terms, most people are losing money in what they see as a risk free account.

Stockmarket
Over the long term, through growth and dividends, it is possible to make significant gains. However, first-hand knowledge, or a lot of luck, is required to make the most of stocks and shares. Most people tend to have neither. In addition, most people are not prepared to take the rollercoaster ride that stocks and shares tend to produce.

Structured Notes
These are, generally, complicated and inflexible products which are really only suitable for experienced investors. The gains can be based on a variety of things but often requiring 5 to 6 years before seeing any return.

Property
Over time, property has proven itself to be a winner. However, it has also proven that it can suffer massive reductions. It is also probably the most illiquid asset you can hold as well as potentially, the most costly to hold in terms of upfront costs, taxes and maintenance. There can also be emotional risk.

Under the mattress
This is often mooted as a home for money in times of uncertainty but then there is the risk that it could go up in flames or end up in a burglar’s swag bag.

The solution?
As financial planning advisers, we are in a position to offer the best of all worlds; the potential for growth in a low risk environment. By Investing in a Spanish compliant insurance bond, with a company that is one of the strongest in Europe, holding a variety of assets, including shares, bonds, cash and property (but not the mattress), one can achieve steady growth. There is also the facility to take regular income. Your money can grow tax free within the bond until money is withdrawn. Even withdrawals are taxed favourably. Two potential advantages; higher growth and lower taxes. Perfect!

* Source: Financial Express (12 months to 23/11/15)