Savers must start becoming investors

May 8, 2009

david-kuo_motley-foolthumbnail- David Kuo is director at The Motley Fool. The opinions expressed are his own. -

The Bank of England Monetary Policy Committee decided to leave interest rates unchanged at 0.5 percent in May. This came as no great surprise given that the Central Bank has already slashed interest rates to a level where further cuts would have made no discernible difference to the cost of money.

That said, there are other ways to drive down the cost of money. In this regard, the Central Bank still has plenty of gunpowder left in its keg to blast the UK economy out of the doldrums. So far, it has only printed two-thirds of the 75 billion pounds of fresh money authorised by the Government for quantitative easing. It can pump in another 75 billion pounds into the economy after that. So, in total, it has 150 billion pounds in its armoury.

It can be argued that the Bank now has little choice but to continue pumping money into credit markets through quantitative easing given that cutting interest rates has not worked. After all, the problem that that UK faces is not the cost of money but instead the quantity of money.

Curiously, pumping 50 billion pounds into the credit markets has yet to have an effect on broad money growth. But at some point quantitative easing will increase money supply. However, it will come at a heavy price – inflation.

Of course inflation appears to be subdued at the moment, though this depends on which inflation index is used to measure the rise in the cost of living. The Retail Prices Index (RPI) has fallen to zero but the Consumer Prices Index (CPI) rose from 3 percent to 3.2 percent. The latter, which excludes mortgage costs, suggests that the cost of living is still going up at a time when consumers have little appetite to spend money.

The danger for consumers is that when Quantitative Easing begins to work, the surge of money and credit into the economy could boost inflation significantly. It is therefore vital that savers ensure they are properly invested in assets that keep pace with inflation.

Comments

Having down sized a house I was persuaded to invest the profit, rather than save in a higher interest account, on the basis that was the only way to keep up with inflation. I am now down about £8000 even though it was invested in cautious funds. My retirement is now to be as my life as a widow has been, scrimping to pay bills and put food on the table. Never again.

Posted by barbara | Report as abusive
 

Aggressive rate hikes could be on the cards once inflation becomes evident, which is good news for savers. They have endured a torrid time of late.

Posted by Joe 90 | Report as abusive
 

Mr Kuo you are absolutely and totally right with your analysis. Just one minor little element is missing from it and you could become the richest man in the world.
Which assets are you talking about????????

Property? Shares? Gold? Land? Commodities? or maybe the most precious of all: our planet, with only one minor problem – in order to spare that one, we need to consume less.

Posted by Esther Phillips | Report as abusive
 

The Motley Fool has always liked shares, especially Index Trackers, so I expect David Kuo would suggest the stock market. However, only a real fool puts money into things he doesn’t understand.

Posted by John Clark | Report as abusive
 

Could you give me the list of investments that I can place my money where there will not be a loss over the next three years? At the moment my money is staying in the bank where I know I will get something and not lose. If Warren Buffett can be praised for outperforming the market by losing only 9% last year, I, as a white collar worker, will be glad to outperform him by almost 10%.

Posted by Richey Rea | Report as abusive
 

what a absolute load of rubbish! the recent rise of the stock market is engineered and false, check the fundamentals for yourself, dont be fooled into believing the massive debt fulled crisis has been solved by issuing more debt! the toxic assets have not been brought onto the banks balance sheets in the so-called ‘stress tests’ the only stress involved on the banks behalf was that they werent allowed to write the rules more in their own favor than they already were. The housing market is still in massive worldwide decline, unemployment is sky rocketing and the debt owed by the various governments will not be paid off for several generations. if that sounds like a rosy senario for the worlds financial markets then by all means pough your money into a hugely volitile market senario, whilst the smart money makes a swift retreat out of the stock markets.

it has often been said a fool and their money are easily parted, and with the help of this joker it makes the parting swifter and sharper! cant believe anyone will take this article f0ranything but barefaced market ramping!

Posted by c0oncerned bystander | Report as abusive
 

I retired after 40 years of hard work, thinking my savings, earning a low 6%, plus my OAP would provide enough for a simple lifestyle. I invested most of it in ‘safe’ shares, on the advice of some who should have known how ‘safe’ it was (and probably did). Mr. Kuo may know them.
Like millions of other pensioners I rue the day I ‘invested’. Advice from such as he, that we should again chance being ‘taken’, is abrasive cheek, not to say crass nerve.
Far more sensible that we got decent interest on our remaining savings, enabling us to spend a bit more and improve money circulation, instead of
relying on companies to lose it.

Posted by D.Thomas | Report as abusive
 

Do you think that this government will worry when inflation becomes a problem? They already are letting it be at 3.2 % when it should be no more than 2%. The government will allow your money to depreciate to help them get out of the mess they created. I saw this article on the web somewhere that governments are going to let inflation get out of control so as to save themselves and get of the hook. This is an absolute disgrace to all of you in the UK.

Posted by miles heater | Report as abusive
 

Hi Esther,

I couldn’t agree with you more. Inflation occurs when too much money is chasing a limited supply of goods. So, if we all consume less then inflation could be kept under control.

Unfortunately, that’s easier said than done when £150 billion will be pumped into the British economy. Not everyone will be as restrained as you or I, which is why we need to be vigilant and ensure that our savings are invested in assets that keep pace with inflation.

Over the long term, only two asset classes have beaten inflation, These are property and shares.

Regards

David

 

QE essentially allows banks and the government to borrow money more cheaply. Inflation and deflation are what occur in a capitalist system when there is money and an imbalance between supply and demand. We saw this recently in that whereas shoe prices and TV prices (CPI stuff) have dropped due to more than adequate supply (China / globalisation effect) we have also had massive house price inflation. Supply and demand is not the whole story though, the supply of money or the amount of money available also effects inflation and deflation caused by supply and demand imbalance. If the most money available to me to make a purchase is £2 then I will only be able to pay £2 for whatever it is. If a bank is willing to lend me another £10 then suddenly, if I am willing, I can pay £12 or 500% more than otherwise possible. Although the BoE has been buying bonds the banks have not rapidly increased lending either to individuals, corporations or each other. The deterioration in the public finances is also causing the cost of government borrowing (treasury yields) to increase and hence the amount the government is likely to spend in the future will either have to decrease (deflationary) or tax rates will have to rise to fund the budget deficit(deflationary) unless economic growth once again causes tax intake to rise. Hence the question is whether banks will begin lending in a way they did a couple of years ago to fund consumption and hence boost the economy and get tax receipts back up etc. Present figures suggest that they won’t, mainly because most of them have only just narrowly escaped bankruptcy from the last lending binge. Most have already tightened up their lending criteria and capital ratio requirements (interestingly enough this has actually been imposed in the States by the government with the ‘stress tests’ though the Public-private initiative, the PPIP, to remove toxic assets from banks balance sheets could perhaps give these institutions a new lease of life). So, in the UK we can actually see that the picture is more deflationary than inflationary over the next decade despite the BoE’s best efforts though people/institutions that are able to access the large amount of money available to the banks should find that they can get that money cheaply. Unfortunately they probably won’t want to spend it on much as most assets (stocks, cars, fridges, computers, gardening equipment, tennis rackets, bonds…) will be dropping in price due to the ease at which these things are cheaply mass produced or issued. Housing is an interesting question in the UK as there is still a lot of demand it is just a question of whether sufficient people will be able to access funding or be willing to pay the asking price which is very skewed historically. We do however live in a globalised society and hence increased demand in places like China and India will effect us here mainly by causing things like the cost of oil (and hence petrol and gas) and meat and sugar and aluminium and copper to rise as the global market for these products and the reduction in the value of the pound cause the purchasing power of people whose incomes are in sterling to decrease. Fortunately as I have said the price of the things made from these raw resources will decrease due to effiecient production; however, the cut throat competition that causes such deflation will mean increased bankruptcies (bad for corporate bonds and equities and your job prospects). And that is the economic forecast according to Luke. However, as I admit I could be wrong a balance portfolio of assets is the best way to conserve your wealth and stocks have historically outperformed bonds in the long run though it might take about 20years for that to be true if investing now and the spectre of bankruptcy will haunt those of you brave or foolish enough to pick your stocks. If you have retired and are looking for supplementary income then permanent interest bearing shares from a building society like Nationwide are currently yielding about 6-7% but if inflation does kick off then this kind of thing will not do well so it needs to be balanced with some exposure to the stock market preferably through things like investment trusts with a professional manager and a discount to NAV. RIT captial partners has had a lot of good stuff said about it. I like the fact that it is not benchmarked, it has a long term prospective and is 17% owned by the chairman who is a Rothschild. I am not a professional, I have no qualifications and you’re a fool if you heed my advice. DYOR.

Posted by Luke | Report as abusive
 

Hi Barbara,

There are always risks involved when investing in shares. That’s why we, at the Motley Fool, believe that you should only invest money that you won’t need for at least five years or more.

There is a rule of thumb that says a good guide to the percentage of your portfolio allocated to cash should be your age expressed in years. In other words, if you are 50 years old then you should have 50% of your portfolio in cash; 60 year olds should have 60% in cash, and so on

It’s only a rule of thumb, but I think you get the idea. As you get closer to retirement, more of your portfolio should be in cash.

Regards

David

 

Hi Hoe 90

A consequence of inflation will be interest rate hikes from the Bank of England. Savers should benefit from higher savings rates provided high-street banks pass on the Central Bank’s rate increases. It’s more likely that the cost of borrowing will go up lots but the benefits of savings will be less.

David

 

Hi John Clark,

The Motley Fool believes that we should all try to take charge of our own finances. There are many places to invest your money, of which the stock market is one. But you should only invest in shares if you understand what you are investing in.

David

 

Hi Richey Rea,

No one can fault you for leaving your money in the bank earning interest. That’s because cash is the least risky asset classes we can invest in. If you invest in shares, you should only do so with money that you won’t need for at least five years.

David

 

Hi c0oncerned bystander,

The market fundamentals show that the FTSE is currently valued at a P/E of about 10. In other words you are paying £10 for every pound of profit that UK companies make. That doesn’t strike me as too expensive. The dividend yield is about 4.6%. Over the coming weeks we’ll be able to gauge how many companies raise, hold or cut their dividend payouts. It can be an indicator of how confident they feel about the future.

Turning to the housing market, the price of a typical home in Britain is around £155,000. According to Halifax, this is roughly four times average earnings, and is down from a high of 5.8 times earnings in 2007. House prices still feel a little expensive, but then again, I have never looked at my house as an investment – it’s my home.

You are right to point out that unemployment is likely to rise. That is what happens in a recession as businesses scale down their operations to match demand. My philosophy has always been to live each day as though I will lose my job tomorrow, which is why I try to invest my money carefully.

The Motley Fool has always said that you should only invest in what you know. You clearly have a lot of expertise in many areas. So, you shouldn’t have difficulty in finding something the suits your needs.

Good luck!

David

 

If you say the problem is not the cost of money but the lack of money. So how could one say money is cheap if, at the same time, saying that money is scarce?

Posted by Jerry Simonsson | Report as abusive
 

Hi Jerry,

It seems paradoxical, I know.

The best analogy I can think of is that of gardener trying to water his plants with a garden hose. The hose is properly attached to a tap, and the tap is turned on. But there is precious little water coming through the nozzle of the hose. The problem is not that the tap is broken but instead, there is a kink in the hose.

Banks have cash. But they are reluctant to lend it, which makes cash scarce. HSBC, for example, recently raised £12.5 billion through a rights issue, and the Bank of England is filling up the high-street lenders’ coffers by the billions. However, banks will only lend the money to borrowers with, what they consider to be, the right credentials.

Fix the kink and the water will flow. But don’t be the one staring down the nozzle when that happens!

David

 
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