If you are 40 would you put all your savings in cash for the next 20 years?
William Hague wrote a fascinating and passionate article in the Telegraph entitled “Central banks have collectively lost the plot. They must raise interest rates or face their doom”.
Some of what he says I agree with; particularly the challenges with the route taken by central bank being that we don’t know what the final outcome might be. However, there are several things that I take issue with and I think reflects a changing society that is being missed by the likes of William Hague, Theresa May and others.
Pension funds have poor returns
One of the points William Hague makes is the social divide and the rise of “populist” campaigns. As we call it “the haves, and the have nots”.
William Hague is referring to final salary schemes; companies established these schemes decades ago and they promised a guaranteed pension to employees in retirement. Even before 2008 companies were struggling to meet the liabilities of providing these guarantees and so more and more of these schemes were closed, and this has continued so there are very few (if any) schemes open to new employees.
There are many arguments why these schemes no longer work but longevity plays a part; people are living longer in retirement and they were never designed to provide an income for the length of time now expected as the cost is too great.
Interestingly this is an example of social inequality to which William Hague refers; MPs and public sector workers are really the only people lucky enough to have these schemes! Most people now have to save into a pension pot and the amounts they would need to save are staggering even to get a basic pension.
William Hague is not completely accurate in his assumption that pension funds have declined because of central bank policies. In part this might be true but they have suffered from a lack of funding from employers, poor investment decisions etc. What he also seems to forget is that the schemes he is referring to sadly reflect a thing of the past, which only the likes of himself and other MPs can enjoy. A classic example of social inequality which he is keen to stamp out.
Savers find it impossible to earn a worthwhile return
In the UK, and perhaps in other countries, we seem to think that savings is solely about cash.
If we go back in time the standard option in retirement seemed to be to put all our savings in cash. There were perhaps two reasons for this, firstly timescales i.e. people were not expected to live so long in retirement and therefore protecting money was important, and secondly interest rates were much higher. We have said in previous blogs how in the 1980s the average savings rate was 8.95%, but by the 2000s it had dropped to 4.40% and has since fallen to 0.49%.
The fact is that saving rates have been falling since 1998; that is nearly 20 years of decline, which is not something new. It reflects a changing society where interest rates dropped from 17% at the start of 1980 to 5.50% in 2007.
When you build in inflation and long-time horizons, cash shouldn’t be seen as the only option for savers.
One question I often ask is this:
“If you are 40 would you put all your savings in cash for the next 20 years?”
The answer is more often than not, no.
Turn it around if someone retires at 60, they are likely to live till they are 80 plus, should they put all their money in cash? The answer is again most likely no.
Interestingly those who are angry about cash seem to be the “haves”.
This is the generation who still benefit from the guaranteed pension schemes, who stick their money in cash and have houses which they have owned for many years. These are the people the “have nots” are angry about. This is the generation who really don’t understand the challenges facing people starting out today.
Populist anger is not against cash saving rates; yes, there are a growing number of pensioners who are angry because they are not getting 8% on their cash savings, but frankly many benefit in other ways.
And going back to the 40-year-old if they were saving for twenty years then they shouldn’t just be saving in cash, it should incorporate riskier assets. If you are saving for a holiday or a car or deposit on a house, that is different and you accept that interest will be minimal because you want to protect that money for the end goal, but not when you are saving for retirement.
Raising interest rates
Similar to William Hague I am no economist, but what a crazy idea!
We are in a new economic environment; this is a financial landscape which we have never seen before. We cannot map it back to history because there is nothing to map it against.
We are also in an environment where there has been massive technological change and moving forward there will be more. Technology drives down costs and therefore we cannot expect the same levels of global growth that we have seen in the past. Global growth will be lower.
Let’s say William Hague is right and interest rates in the UK have to go up, where do we stop? Let’s say we go back to 2007, interest rates at 5.50%. Currently rates are at 0.25%.
It is not rocket science to work out the consequences of this – mortgage payments go up. The consequences of this are that some will no longer be able to afford the repayments so repossessions begin which starts to drive down property prices. Declining prices brings negative equity, and for those who can still afford the new payments, it means they have less money to spend which then impacts the UK economy.
Sounds familiar; during the 1990s interest rates peaked at over 15% at one point, house prices crashed, repossessions increased, many lived in negative equity and people felt generally less well-of.
William Hague and others are suggesting (at a time of great uncertainty for the UK economy) when you need to keep people spending, the best option is to raise rates at the same time as a weak sterling increases cost of basics like food – a double whammy!
The real winners of this move are likely to be the “haves”; yes their house might go down in value but that is likely to have little impact on them. They will continue to receive their guaranteed pension and their cash will start to get more interest! I would like William Hague to let me know where the equality is in that?
House prices have gone up a lot but in reality they should have gone up a lot more. Buying a house for £40,000 in 1990 with a 15% interest rate, and the same house today for £200,000 with a 0.25% interest rate is perhaps the same cost in monthly payment terms. The ‘asset rich’ people are those who have held their homes for decades and this is not your average homebuyer.
If William Hague and others get their wish and force up interest rates, then it will likely decimate the new generation of homebuyers.
And as for shares, this is a sweeping statement. Only recently the FTSE 100 was at the same level as it was in 2000. There had been no growth for over a decade. This is not an over-inflated stock market! Recently the stock has gone up above 7,000 but this is because of sterling and the fact that several FTSE companies have overseas earnings and therefore benefit from a weaker pound.
What should William Hague and others do
I’ve come to the conclusion that rather than living in the past we need to see this for what it is. We are in a new environment, this means lower interest rates, and for longer. Interest rates might get to 2% or 3% by 2027 but why should they go any higher?
We need to understand that gold-plated pension schemes are a thing of the past and William Hague and others should be trying to work out how young people can save for their retirement, where there is no longer a guaranteed income provided via these pension schemes.
We also need to educate that saving is not just about cash; which is great for short term savings, but long term things have changed. Yes, this will mean using riskier assets but risk is not a bad thing and can be reduced with careful planning.
In summary, William Hague is in part right but his arguments actually will only benefit the “haves”. If he wants to help I would ask him to accept we are in a new economic environment which involves lower interest rates, and that he looks to educate people on saving for retirement and in particular in an environment where this is much more difficult for the average person.
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.