Newspension information

What is a risk-free rate of return?

By January 23, 2015 No Comments

What is a risk-free rate of return?

The science of capital markets has been built on the concept that investors are due a return over and above the prevailing ‘risk-free rate’ in the market. This excess return is the ‘risk premium’, and rewards investors for taking on higher risk (i.e. capital volatility). Or so the theory goes. The common held belief is that the rate of risk free return is the yield on government loans. Largely the US, but in the UK, Gilts are commonly viewed as the benchmark. Basically investors do not believe the government will go bust so there is no risk.

Why is this important?
Clearly, as we have said before, all is not well in the world. The free fall in the price of oil being just one example.

Today we have seen the European Central Bank launching a trillion Euro quantitative easing programme. It aims to buy up 60 billion Euros worth of securities a month over the next 15 months. The purchases will include public and private sector securities.

There is a strange parody to this position. As noted the US treasury stock or UK Gilts are viewed a risk free return assets. Today the 10 year US Treasury bond provides a yield of 1.83%. 10 year UK Gilt 1.51%. So to get these returns in a risk free environment you need to tie the money up for 10 years.

The parody is with all the talk of issues in Europe, especially Spain’s fragile status, why does a Spanish 10 year government bond only have a yield of 1.46%. That is less than the UK and the US. To balance this, Germany, “the powerhouse of Europe” only provides a yield of 0.5% per year for tying money up for 10 years!

The fact is with these interventions, we really are not going to see interest rates heading north any time soon, which has a huge impact on savers and anyone looking at annuities for their pensions. Equally those in final salary company schemes, there potential transfer value is probably going to be the highest it will ever be.

Last week NS&I launched the pensioner bonds with attractive rates. 4% per annum if you tie up for 3 years looks monumental compared to all the above Government loan stock. On the flip side, since their launch according to a report in the Daily Mail, the interest rates on over 100 different savings accounts provided by banks and building societies have dropped.

Inflation figures in the UK are close to 1%. With deposit rates being so slow, it is a relief inflation has dropped, but inflation at these levels brings its own issues, and is not a policy any Government would want. The target is 2%.

If you are not 65, and so do not qualify for those in demand pensioner bonds, or if you have used your £10,000 per issue allowance, where do you go? The question of course is where do you put your money to get a return.

The answer is a diversification.
No investment is a one way street. We, nor anyone we know, has a crystal ball. What we do know is that different investments perform differently at differently times and we cannot tell you which will be the best and worst over the next 12 months, 3 years or 5 years.

There is a chart called a Ritzholt chart which you can look up. It looks like a patchwork quilt!

It is quite interesting to see the visual nature of how each asset class moves up and down in the return ranking each year. There is absolutely no consistency or pattern.

Therefore the only way to invest is to seek a risk rated multi asset investments, managed by professionals that apply a consistent and clearly defined approach. We strongly believe this provides a diversified and lower risk route to making a better return on your money.

With interest rates set to remain low and the risk free return offering less than 0.5% real return, it may now be the time to look at what you could achieve.

For more information, contact us for an informal chat about this or any other financial concerns. 

Each adviser in the company has over 25 years’ experience in helping clients achieve their financial goals. Our team is at the heart of our business, and is committed to delivering an excellent customer experience for all our clients