Every cloud has a silver lining
We all know the impact the credit crunch is having on the cost of borrowing - the mortgage market is in a state of flux, while credit card companies are cracking down on who they lend to.
Meanwhile, the housing market slowdown continues, fuel and food prices are creeping upwards and global stockmarkets are still looking turbulent.
But is it all doom and gloom? They say that every cloud has a silver lining, even if it isn’t always that easy to spot.
So is anyone winning as a result of the credit crunch?
The impact of stockmarket turbulence on pensions might make delaying your annuity purchase seem like a good idea. But research shows that putting off buying an annuity could leave you worse off, especially as annuity rates are currently at a five-year high.
According to Hargreaves Lansdown, there have been 17 annuity rate changes in the last month alone, 88% of them upwards. It estimates that today’s yield for a 65-year-old male is 7.66% per annum, up 10.5% from March 2006 when the yield was 6.92%.
The IFA says the current price war at the top end of the annuity market is good news for those people looking to get as much income from their pension as possible.
The increase in annuity rates is mainly down to the effect the credit crunch is having on corporate bonds, which most annuity providers use to back their products. The credit crunch has put pressure on the value of these bonds, which in turn has increased their yields.
With increasing inflation a real risk in the UK as a result of lower interest rates and rising food, fuel and mortgage costs, yields are likely to continue to be pushed up, further boosting annuity prices.
Nigel Callaghan, pensions analyst at Hargreaves Lansdown, says: "Equity values have recovered to some degree since the market falls in January, and looking at current annuity rates we are starting to feel that this may in fact represent an opportunity for investors.
"Yields on corporate bonds have widened significantly since last summer, which many retiring investors are taking full advantage of by locking into the highest rates since 2003."
Despite the current sunny climate in the annuity market, there could be clouds on the horizon.
The risk of increased inflation is putting upward pressure on annuity rates, but there are several other issues lurking in the background which could drive rates down.
For one, increased life expectancy means annuity providers have to pay out for longer, which is eating into their collective pot of money. As this trend continues, annuity rates are likely to fall.
Secondly, Callaghan says many corporate bond managers believe the markets have already priced in the majority of the bad news. Again, this could mean the gap between rates and yield could close, driving down rates.
Callaghan adds: "It’s impossible to know for sure exactly what will happen to annuity rates going forward. If the economy does nose dive, companies and individuals find it more difficult to borrow and inflation takes off, rates may stay at these levels or could even be forced higher still. It really depends on whether you have a bearish or bullish outlook."
In recent years the availability of cheap credit has made us a nation of spenders. But the credit crunch is likely to change all that, as borrowing gets harder. First-time buyers are already likely to be focusing on saving for a deposit to get on the ladder, while others are probably planning their savings strategy to protect themselves from potentially tougher times ahead.
The goods news is that saving rates are looking more attractive at the moment than they have done for some time - and this is largely thanks to the credit crunch.
As banks and building societies continue to struggle to secure institutional funding for their mortgage and loan operations, the importance of retail deposits has become more important. To that end, many are offering attractive saving rates to entice customers through their doors.
Tim Hague, director of savings and investments at Birmingham Midshires, says: "We expect savers to continue to get good value for money from their savings accounts - there will be even more competitive pricing throughout 2008 as providers vie for the attention of savers. We recommend that savers have at least three months’ salary in savings."
While attractive saving rates are good news for consumers, how long they will last remains to be seen.
On one hand, the frozen credit markets mean banks are looking for alternative ways to raise funds, and are increasingly focusing on savers.
However, Rachel Thrussell, head of savings at Moneyfacts, says this is squeezing their profit margins: "In the short to medium term banks will want to continue attracting savers, but at some point they will have to sit down and ask how sustainable this strategy is."
When the economic cycle is at a low point, a move into defensive sectors is well worth considering as these sorts of companies are normally well-positioned to withstand a recession.
Some have already benefited from turbulence in 2007. For example, Matt Pitcher, wealth adviser at Towry Law, says people who invested in gilts directly through an ISA or pension last year have benefited from their excellent performance.
But, as Pitcher points out, when it comes to investment you should never look backwards but rather to the future. While sticking to defensive sectors might be a good strategy during the hard times, it is unlikely to make you serious returns over the long-term - especially with commodity prices at an all-time high.
Philip Pearson, from IFA P&P Invest, says: "The credit crunch will not be here forever. The key to finding value is finding investment opportunities that have taken a hit and have room for recovery."
Pearson says equity income funds represent good value at the moment as many have up to 30% weighting in financial firms. He adds: "There is a spring sale in equity income funds at the moment and if you are a mid-term investor then you should fill your boots up.
"These have been hit by the credit crunch because of their weighting in financials, so they represent good value."
Pearson also likes the look of recovery funds and special situations funds: "These are good funds to have as they seek value from firms that have fallen out of favour or have had a poor performance."
Meanwhile, Pitcher recommends investors consider equities and commercial property funds, as prices across both are well below what they have been in recent years.
They may not actually be benefiting from the credit crunch, but Scottish homeowners might not see the fall in house prices that the rest of the UK is facing.
According to the latest Halifax house price index, the price of the average home in the UK is likely to experience a single digit fall in 2008. However, the bank’s chief economist Martin Ellis believes that Scotland could be one region to actually see modest rises in prices.
He says: "Scotland won’t necessarily buck the trend - there will be a slowdown in the rate of house price growth - but because house prices in relation to earnings is relatively low, affordability constraints are not as dire as elsewhere in the UK. In 2008, Scottish house prices could rise by up to 4%."
A report from estate agency Knight Frank also suggests that the housing market in Scotland could prove more resilient to the credit crunch than in England and Wales.
It believes that high rates of employment in the financial sector and demand for city centre homes from young professionals place Scotland in a strong position to withstand the slowdown.
Knight Frank says house prices rose by 13% in Scotland last year, the biggest increase outside of Greater London. It predicts that 2008 will see prices increase a further 1%, compared to average falls of 3% in the rest of the UK.
Londoners could also be spared the sharp end of the credit crunch. Although job cuts in the financial sector are likely to hurt house prices in the capital, Ellis says the market has so far proved pretty resilient.
He says: "Greater London is likely to fare better than the rest of England and Wales because there are special factors at play - but it will not be immune to the credit crunch."
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
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%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The managers of these funds look for shares in companies that have fallen in price and popularity for reasons such as operational difficulties, management changes or financial over-extension, are unloved by the market but have the potential to recover over the long term. Managers of recovery funds focus on buying these undervalued companies where they see significant potential that should lead to a turnaround in their fortunes, a renewed appreciation by the market and that recovery will be reflected in the share price.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
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.