Interest rate update: strategies for financial advisers

How do interest rates affect financial advisers?

After inflation hit the Bank of England’s 2% target in May 2024, the bank held interest rates at 5.25% in June. This was the seventh time in a row that the BoE voted to keep rates at the 16-year high, although it did indicate that it would be open to cutting rates in August. However, this will happen only if the BoE is confident that prices have stabilised. 

Numerous factors affect interest rates, some of them being inflation, economic policy, credit risk, global economic conditions, political events or political instability, and the demand and supply of money. 

The BoE stressed that the June 2024 vote to keep the interest rate at 5.25% was an apolitical decision that was not influenced by the upcoming election on July 4, 2024. However, elections in the UK or anywhere else increase uncertainty, which in turn affects corporate decision-making as well as consumer behaviour. 

In the UK’s case, the BoE began raising the interest rate in response to the underlying inflation pressures it identified in 2021, becoming the first major bank to do so at the time. The first raising of rates brought the UK’s interest rate to 0.25%. High interest rates result in increased borrowing costs and potentially slow economic growth, while low interest rates lead to reduced borrowing costs and increased spending and investment. 

These changes also affect financial advisers. As changes to interest rates can be unpredictable, advisers may need to revise their financial investment strategies, sometimes making drastic changes to client portfolios. Financial advisers also need to rethink how they plan for further changes to interest rates.

What can be the direct effects of high interest rates?

Increases in the interest rate have numerous direct effects. Among them are increased difficulty with financing and borrowing, investment portfolio depreciation, and the need to revisit strategies.

Increased difficulty with financing & borrowing

One of the most noticeable effects of interest rate increases is the increase in the cost of borrowing. Unless loan interest rates are fixed, this results in higher monthly loan repayments as well as more interest over the remainder of the loan term. 

A higher interest rate can also impact the total amount of money individuals and businesses can borrow, as higher debt servicing costs can affect affordability. For people who have borrowed money, the higher cost of living associated with inflation and high interest rates can mean difficulties in repaying their loans. 

A Financial Conduct Authority survey found that 7.4 million adults in the UK are struggling to pay bills, with 5.5 million adults having missed a bill or credit card payment in the six months to January 2024. You therefore need to think carefully about the interest advice they offer clients. 

Depreciation of investment portfolios

Rising interest rates can lead to the depreciation of clients’ investment portfolios, which means financial advisers need to find ways to increase their value. The rate hikes over the last three years have been particularly bad for ‘fixed income’ investments, especially bonds.

A higher interest rate might lead to lower bond prices, which is not good news for some clients. Some investors have continued to see the negative impact that began even before the interest rate reached 5.25% in August 2023. 

The average global government bond fund lost approximately 10% between the beginning of 2022 and September 2023. However, these lower prices can make purchasing bonds more accessible, which is something that you can capitalise on when developing a financial strategy for investment.

The need for a full strategy revisit 

If the interest rate rises unexpectedly and continues for an extended period, it can lead to the need for a full financial adviser investment strategy revisit. You may need to reassess clients’ portfolios to find ways to mitigate negative impacts or recoup losses by rebalancing a portfolio.

How do you navigate increases in interest rates as a financial adviser?

Financial advisers can use multiple strategies for navigating increases in interest rates and their impact on financial markets and investment strategies.

Keep updated with changes in the market

As a financial adviser, you know that there’s a link between interest rates and the financial markets, which are infamously volatile and change continuously. Keep updated with changes in the market so that you are aware of emerging trends in the global and domestic markets so that the investment and interest advice you give to your clients is reliable and actionable. 

If the BoE does reduce the interest rate in August, the next government will benefit from those lower rates, which will make it easier for the government to roll over its existing debt and issue new debt.

Prime Minister Rishi Sunak said that interest rates will come down if he is elected. However, any reduction in the Bank Rate will be a result of the BoE setting the interest rate in line with the current inflation rate. This is because the BoE, not the government, controls the interest rate.

Some of the ways you can do this include following news headlines from around the world by using a news ticker or news aggregator, tracking market trends such as investment interest rates and commodity prices using tracking software, keeping up with industry trends, listening to financial and investing podcasts, and using market forecasting tools.

Reassess asset allocation

One of the potential impacts of rising interest rates is the need to fully revisit financial investment strategies. Doing so provides you with the opportunity to reassess asset allocation with the goal of further diversifying client portfolios and finding the best interest rates on investments. 

By spreading investments across various asset classes, geographic regions, and industries, you can reduce a portfolio’s overall risk. Doing this makes it possible for one asset’s poor performance to be offset by another asset’s better performance for greater consistency when it comes to overall returns.

If a higher interest rate is negatively affecting entities within the UK, you can reallocate assets and broaden a portfolio to include entities in other geographic locations with more favourable interest rates. 

If August 2024 brings lower interest rates, growth should return to trend progressively. This should add renewed attractiveness to new investments, although this is likely to be most apparent from 2026 onwards.

Tax-friendly investing

Tax-efficient or tax-friendly financial investment strategies have been an important consideration among investors who want to maximise returns while minimising the risk associated with their investments. 

According to a 2023 FCA survey, 37% of respondents said tax efficiency will play a bigger role in their investment strategies. This figure rose to 53% among investors aged 18-34.

According to Growth Capital Ventures, financial advisers in the UK usually recommend five main options to investors: individual savings accounts (ISAs), the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS), and Venture Capital Trusts (VCTs). An FTAdviser Talking Point poll revealed that 48% of advisers said their clients used ISAs and pensions as tax wrappers more than any other tax-friendly option. Only 4% of respondents said their clients invested in VCTs. 

For example, you could create a financial adviser investment strategy for a client in which you spread their investments across a range of tax wrappers aligned with their goals and objectives. This can help them to legally reduce their tax liabilities and help them keep as much of their returns as possible. If EIS or VCTs are among those tax wrappers, your clients will provide start-up businesses with funding while receiving income tax relief of up to 30% on the investment, as well as capital gains and inheritance tax benefits.

Consider buying stocks

Buying stocks can help financial advisers navigate increases in investment interest rates, especially when those stocks are in the financial sector. Entities such as banks, brokerage firms, insurance companies, and money managers see their profit margins expand as the interest rate rises. Another option is to take a defensive position by buying stocks in healthcare, consumer staples, and physical assets such as gold. 

A 2024 Finder survey found that 23% of respondents in the UK have invested in the stock market. This was a 34% increase in the number of British investors in 2023.

For example, you can buy stocks in top UK banks such as NatWest Group and Barclays as part of a revised financial markets and investment strategy.

Monitor your cash flow

By monitoring cash flow, financial advisers can ensure they have enough cash to meet their short-term obligations. This can also help them identify and address any cash flow issues. Cash flow monitoring can also be integrated into financial investment strategies and interest advice for clients.

For example, if a client looks set to have cash flow difficulties within a few months, you can look for short-term investment options that could offer them an injection of cash when needed.

How can you prepare for a future of unpredictable interest rates?

There are various ways financial advisers can prepare for the future regarding interest rates. Three tips for doing this are to:

Sell assets: It’s possible to profit by selling unneeded assets such as property before the interest rate rises again. Buyers may be willing to pay premium prices if they are able to lock in low long-term rates from lenders.

Buy short-term/floating-rate bonds: For decreased portfolio volatility, invest in bonds with short-term maturity dates or in bonds with coupon rates that float with the market rate.

Set up an inflation hedge: Take advantage of investments that are better equipped to deal with interest rate hikes, such as REITs, commodities, and UK index-linked gilts.

Want to work with Unbiased? 

Rising interest rates cannot be ignored where financial markets and investment strategies are concerned, as they can impact these strategies and portfolios negatively. However, you can use a number of different strategies to mitigate those effects for consistent overall returns. 

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