Enjoy higher interest rates

When putting together an investment portfolio, many people will include cash as well as shares or collective investments such as investment bonds and unit trust and property, in order to achieve what is called “asset class mix”. Put simply, not putting all your eggs in one basket means that if one asset class falls in value, the others may not – or at least not to the same extent, so that overall, the value of investments is not so severely affected.

Of course, the other side of the coin is that when investment values rise within one class, others will not benefit in the same way. But on balance, many people believe that they are likely to win more that they lose, by adopting a diverse investment strategy.

However, when there is an underlying shift in one asset class – in this case a 27% increase in base rate from 4.5% to 5.75% in less than 12 months, with little prospect of a softening of rates within the foreseeable future – it could be time to consider a re-balancing exercise.

While the FTSE100 grew by over 13% during the year to the end of June 2007, and the FTSE250 by more than 22% in the same period, such a substantial hike in interest rates at least means that it is worthwhile considering whether some of the gains made on equity markets should be locked in to cash, while interest rates are so attractive. After all, past performance is no indication of what will happen in the future, which is why actively reviewing your asset allocation strategy is so important.

There are others who might benefit from higher interest rates, especially if these are likely to be sustained for some time, as appears likely at the moment. Annuities are based not just on life expectancy – which is improving (making annuity rates lower) – but on gilt returns (which are based on interest rates). This means that with higher interest rates, annuity levels could improve, at least marginally. So for those who have been using income drawdown (or unsecured pensions, as we have to call them now) as a hedge against the time when annuity rates might improve, now could be the time to re-consider your options.

Perhaps perversely, those with offset mortgages could also benefit, especially if they have a reasonable level of savings in their offset accounts. The reason for this is that actual repayments are based on the initial mortgage and the current interest rate. Because offset mortgages balance your savings against your borrowings, so that you only pay interest on the difference. So if you have a positive balance in your savings and or current account, you are almost bound to be overpaying, each month. This means that your balance is going down faster than would normally be the case. If the interest rate rises and your bank increases your payments, then – in an overpayment situation – the speed at which you are repaying your mortgage accelerated even more. Not by much, but every little helps.

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