If you learn one thing from the recession...
People have short memories, which is why the impact of the recession has come as such a shock to many. After all, this is not the first time house prices have taken a sharp fall, stockmarkets have been rocked or unemployment has shot up.
But the circumstances of this recession, brought on by the so-called credit crunch in the US, have given the current downturn it’s own unique feel. And the boom years that proceeded 2007 seduced many people into thinking the good times would never end.
But they were wrong, and the UK has been in recession now for around a year. Of course, even before economic growth turned negative, the effects of the credit crunch were being felt by consumers, from savers and borrowers to investors. And, no doubt, they will continue to be felt even when the recession is finally pronounced as over.
In the meantime, what can we take away from the past 18 months?
Before the credit crunch hit, only the very sensible – or very fortunate - among us could boast a decent savings pot. Many people were so caught up in the ‘buy now, pay later’ culture gripping the UK that we failed to put aside money on a regular basis, while others were happy to dip into any savings they did have as and when they fancied.
But the recession changed all that. With so many people potentially at risk of being made redundant, an increasing number of took heed and started to focus on building up a savings buffer.
According to National Savings & Investments (NS&I), 63% of the population is now more aware of their finances and are making an increased effort to look after their accounts as a result of the credit crunch.
Dax Harkins, senior savings strategist at NS&I, says: “To be in control of your finances it’s really important to keep track of your money and to make sure that it is invested in a savings account that suits your individual needs.”
However, while anyone without significant amounts of debt is well advised to build up a decent savings pot of at least three months’ salary, the credit crunch has also highlighted that we can’t necessarily rely on our savings for income.
Starting in October 2008, the Bank of England has slashed the base rate to an all-time low of just 0.5% - and returns on most savings accounts have followed.
The result has been tens of thousands of people seeing the income from their savings dry up practically overnight. While some have taken the hit, others have made moves to find a more competitive home for their money. This might be other savings accounts or cash ISAs, or even a low-risk investment product.
Last autumn, savers had another reason to be concerned. The run on Northern Rock in 2007 first raised awareness of our savings safety net in the UK, but it was the collapse of Icelandic savings banks such as Icesave in October 2008, and the concurrent banking crisis that saw the likes of Lloyds and HBOS agree to a merger, that really sparked mass panic.
Since then the rules protecting savers’ money have changed, but there is a greater awareness among people about what they can do to ensure they don’t leave themselves at risk.
For example, if you have more than £50,000 with the same bank (or banks if they are part of the same banking group and under the same FSA license) then you should look to move some of your money to a separate home.
Debt and spending
Before 2007, the UK was gripped by consumerism and a ‘buy now, pay later’ mentality. Little wonder our levels of personal debt had soared and credit was nearly as easy to get as a bag of pick n’ mix sweets.
Two fundamental things have changed since then. Firstly, credit is no longer so easy to come by. Interest rates on credit cards, personal loans and overdrafts have risen and lenders are cherry-picking the most worthy borrowers, and refusing applications from people without good credit records.
Secondly, people whp had overstretched themselves are now struggling to cope. Chris Moat, chief executive officer of debt company Fairpoint, says the problem is biggest among those trapped in a cycle of moving their debt from provider to provider. This might have been 0% credit cards or consolidation loans – many even used the equity in their homes to pay off more expensive debt elsewhere.
Now that it is that much harder to borrow money, a large percentage of these people who overstretched themselves have nowhere to turn.
“The majority of people who seek help with their debt have experienced a period of unemployment,” says Moat. “Their income dries up and their debt problems are crystalised. People aged between 25 and 30 are the most affected.”
But it isn’t just people with serious levels of debt that have something to learn from the credit crunch. People who have a manageable level are starting to realise that the best way to boost their incomes is to pay off debt and resist borrowing in the future.
This means not just making the minimum repayment of their credit cards each month, but instead paying off the full amount in time to avoid any interest charges. It also means putting off purchases until they can afford them, or resisting the temptation altogether.
Although not everyone is able to save a significant amount of money, most are able to cut back on the amount they spend on a regular basis. The credit crunch has made budgeting trendy again and there is now no shame in adopting a frugal approach to life.
“Setting aside a few minutes a week is all it takes to review your money situation,” says Harkins. “From this point you can assess your incomings and outgoings, identify opportunities for savings and make your money work as hard for you as possible.”
From dropping a brand in the supermarket, to shopping at charity rather than high street shops, there are many ways that even stretched households can cut back when it comes to spending. And by shopping around to get a good deal on car or home insurance, for example, you could potentially save hundreds of pounds that could be used to boost your savings or pay off debt.
The age-old adage ‘an Englishman’s home is his castle’ looked at risk of dying out when the credit crunch took hold in 2007. The property market – and our attitude to it – has changed enormously since then; house prices are well below their peak, the number of sales has all but dried up and mortgage credit still severely restricted.
The most important lesson that the recession has taught us is that property prices can go up as well as down. It’s hardly rocket science, and homeowners from previous recessions will remember the impact on house prices well. But that’s the problem with bubbles – they’re easily to get caught up in.
“Lots of people bought in to the idea of ever increasing property values,” says David Hollingworth, mortgage expert at London & Country. “While this might be the case in the long-term, the risk happens when you use your home like a piggy bank to fund your spending.”
According to Moat, a vicious cycle built up prior to the onset of the credit, whereby people used the equity built up in their homes to consolidate credit card debt and personal loans. This made sense at the time as it reduced their monthly repayments and the amount of annual interest they were paying.
However, the problem crystalised when credit streams dried up and house prices started to topple.
The over-stretched haven’t been the only people to have been badly burnt by the credit crunch. Buy-to-let landlords and investors who saw property as a way to ‘get rich quick’ may well now be nursing their wounds, as the crash has washed away much - if not all - of their investments.
“Hopefully, the credit crunch will deter people from entering buy-to-let to make a quick buck,” says Hollingworth.
For other homeowners, the main lesson to be taken from falling house prices and restricted mortgage lending is that, in the main, it is preferable to reduce your mortgage debt as quickly as you can. With the Bank of England base rate falling to an all-time low of just 0.5%, borrowers with variable-rate loans have been able to eat their debt by making overpayments.
Hollingworth says: “We’ve seen a move away from people overborrowing on their mortgages to a situation where people are overpaying – hopefully this is something that will continue into the future.”
And what about first-time buyers? Despite house prices falling in value, the lack of mortgage credit means many are still prevented from entering the property ladder. In fact, it’s arguably harder for them as 100% mortgages are no longer available and all lenders are demanding big deposits from new borrowers.
The housing market have moved backwards to a more traditional time, where people had to save to buy their first home. First-time buyers are advised to embrace this change, as it doesn’t look as though the situation will change anytime soon.
“The past 18 months have been an unfortunate time to retire if your pension is in a money purchase scheme or you didn’t move to lower-risk investments – these people have had to make a horrific readjustment of their retirement expectations,” says Tom McPhail, head of pension research at Hargreaves Lansdown.
The credit crunch has had a serious impact on pension pots and increasing numbers of people are having to delay their retirement plans because they simply cannot afford to give up work.
For Matt Pitcher, wealth adviser at Towry Law, the lesson to be taken away from these hard times is the importance of regular pension reviews. Whether you have just started saving for retirement, or are coming up to the day when you can pack-up your desk for good, making sure your pension is invested in the right places for you is vital.
You should aim to review and rebalance your pension around once a year, and when you are getting closer to retirement you should also start to switch your investments into low-risk funds to lock-in the value.
Independent financial advisers have reported a rise in the number of people seeking advice about their pensions during the recession. And with many facing a hazardous shortfall in their retirement funds, it’s little wonder.
“We’re seeing a return to the basic but worthy financial principal of risk spreading,” says McPhail. “You must spread risk in order to protect yourself and plan ahead to ensure you are on track to meet your retirement aspirations.”
He also recommends people remember to pay money into their pension on a regular basis, rather than looks to make lump sum investments as and when. This will spread their risk over the long term and ensure they benefit whatever the market condition.
Unfortunately, the fact remains that many people will have to enter retirement with less money that they would have hoped for. While there are ways they can try and minimise these shortfalls, younger pension savers should take heed and make moves now to ensure they don’t meet the same fate.
“We are now in a world where everyone has to build up their own pension pot and save for the future rather than just rely on the state or a paternal employer,” says McPhail. “This principal was true before but people have a habit of forgetting – hopefully the credit crunch reminded many that there is no subsitute for having retirement savings.”
The past few years have been an exceptionally hard time to be an investor. The stockmarket has experienced more ups and downs than the average rollercoaster, and the value of many assets classes (such as commercial property) have plummeted while traditionally boring investments, such as government gilts, have put on a better performance.
The main lesson most investors should take away is that it’s dangerous to underestimate the risks of investment.
“People have short memories, and the main lesson they’ve had to re-learn is there level of risk in the stockmarket and assets such as commercial property,” explains Pitcher. “A lot of people were shocked at how fast and far the markets went down – it was a real wake-up call.
However, that doesn’t necessarily mean moving away from investment and putting your money somewhere altogether less risky, such as cash bonds, says Pitcher. He believes that investors must return and embrace the basic principal of diversification: “You should have a bit of everything. This mantra’s unfashionable in boom times, but it’s only during a recession that people really understand the value of this approach.”
It wasn’t just the sharp falls seen in the stockmarket last year that hurt investors – many were caught out by the rally early in 2009 because they simply weren’t in the market.
This highlights the fact that no one can time the markets – and that trying to is a risky business. Investment experts say that one way to reduce the risk in all investment climates is to use pound cost averaging.
This strategy, where your money is used regularly to buy investments, enables you to benefit whatever the market condition. During bad times your money will buy a greater number of shares at a cheaper price, giving you a higher overall investment return when a recovery takes place.
“Research shows that pound cost averaging gives better average returns in good markets and bad,” says Pitcher.
A more measured approach to investments seems to be the main lesson people take away from the credit crunch. This means less chasing after yield and more focus on long-term returns.
Pitcher says: “People are always chasing the promise of high returns, but they rarely ask what the catch is. It’s time we started to remember that the bigger the promise, the greater the risk.”
When it comes to investing, the golden rule is that where you put your money will depend on your personal circumstances, such as your attitude to risk, how long you want to invest for and what you're looking to achieve.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.