How much is enough?

I had a couple of weeks away on vacation recently. It’s a time to reflect and to regain some perspective on life in general, as well as to get some sunshine, which has been in short supply in the UK through July and August. Sometimes when you are further away from something, you are able to see things more clearly, though in reality when you’re on holiday you are excused from a number of your regular pressures. This creates more time and space, allowing for a slower more considered thought process. The idea being that we can recharge the batteries, reassess our shorter term and longer term plans, and come back with renewed vigour. That’s the theory at least.

When we set our model portfolios up in March 2008 UK Interest rates were 5.25%, exactly where they are today. Fast forward one year to 2009 and they were 0.5%, where they stayed (on or below) until March of last year. Over that time our Low to Medium Portfolio produced a return of 89.87%. What is important to note however, is that the last 5 years have contributed very little to that number. This is not for want of trying, it’s simply been a consequence of a series of world events, whether it be political or geopolitical, or from a health or economic perspective. The reality is that although our performance relative to our peers in the industry is very good, the actual numbers over 5 years are close to what you would have had from cash over the same period. The old adage, ‘that you can only play the hand you are dealt’ springs to mind, and below is a a snapshot of the returns over the last quarter, to highlight that we are trying to make a ‘silk purse out of a pig’s ear’ at the moment. Things looked good until 2 weeks ago, and might look good again in two weeks’ time…..as markets gyrate on the back of conflicting data. You can see from the chart below that global and UK stock markets, as well as the UK government bond market (key components of any balanced portfolio) have continued to have a torrid time, and of course our numbers aren’t great, though on a comparative basis we have still outperformed.

Of course, our core business at DB Wood is financial planning. Our passion is about helping our clients work out ‘how much is enough?’ to deliver what they need to live their lives, keeping their capital and income tax efficient and HMRC approved, dealing with legislation and tax strategies that preserve clients’ financial legacies as appropriate to their objectives.

Our investment management piece is crucial to this, as its aims to deliver the return assumptions to achieve the planning outcome. The investment environment we’ve had over the last 5 years has therefore been incredibly frustrating. Importantly though there is no point in looking back. ‘We are where we are’ as the saying goes. There is a lot to be said about reminding ourselves of the blindingly obvious, as this undoubtably helps with providing perspective.

So then, where are we and how are we moving forward? Well, to be honest as the graph above shows, it’s still volatile out there. Only two weeks ago, we reported on positive returns in July, though two to three bits of economic data released since suggesting the consumer remains strong, and interest rates might remain higher for longer, has disappointed markets and changed short term expectations. As we have been saying for many months now, the income yield in our portfolios is way above the interest on cash, though frustratingly capital values keep falling, as data emerges around high wage rises etc. As a result, the falling capital value eats into that income, so the income return is only coming through in flashes. Returns will become consistent when the volatility reduces.

So, when will the volatility reduce? I don’t know is the honest answer. We strongly believe that we are nearing the end of the interest rate cycle. The consumer has been far more resilient than I think any economist would have thought at the start of the year. Wage inflation should temper now the Unions have accepted the various pay settlements, and economic growth remains very weak. Logic tells us that capital values will settle as inflation slows and the rate of wage growth subsides.  From here we should see capital values increase, perhaps considerably. This together with the income in the portfolios means the return potential remains significant. This remains our central case.

As always, we are absolutely focused on helping our clients achieve their objectives. Over the course of 2023 it has become possible to get 5% gross from a cash fund. In May this year we launched our money market fund, which is instant access, and is subject to much lower taxation than a conventional bank account due to our tax wrapper efficiencies. Our cash fund is providing close to 5.4% gross per annum on an instant access basis. So, from a planning perspective it is always worth considering what you need to achieve from your portfolio returns to achieve your objectives, and how much risk you need to take to get there. Regular assessment of your objectives in alignment to your appetite for risk should be key to any forward plan.

Cash rates are expected to come down when the economy and inflation slow. Rising interest rates are designed to slow an economy. When that happens, the capital value in our portfolio should rise considerably.  Unless you are invested you will miss that opportunity, as despite all good intentions, trying to time a switch back into a rising market is more about luck than good judgement.

A look back at our Low to Medium portfolio from March 2008 when cash rates were where they are today (relatively high, and then look at what happened over the following decade (above). This is not to say that this will be replicated, that’s not my point, what I am saying is that the government bond value is around the best value it’s been for 25 years, and our view remains, that this will create the foundation for strong returns to come.

On reflection then, we believe we have built considerable value in our portfolios over the last 12 months. We think the forward potential for returns over the medium term are very good, though the start of that consistent improvement is data dependent. We are nearing the end of the interest rate hiking cycle so we are not far away from reaching the top of the hill, and the data will start to point in that direction. That said, as an option, we have an excellent money market fund that provides one of the most competitive instant access cash returns in the market. The choice of where to invest ultimately comes down to the risk you want to take to achieve your objectives, we have all the options to hand, it’s a matter of what feels most comfortable and is best placed to meet your shorter- and longer-term objectives.