Low interest rate alert! What you need to know about maximising returns

Do you have to suffer with low returns due to the base rate being low? Jonathan Smith says no!

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

We live in a world of low interest rates in developed countries. Take Europe for example. Last week the European Central Bank met and decided to keep interest rates unchanged at -0.5%. Think about that for a moment. That means that you would be charged for holding euros in your bank account!

Here in the UK, we do not currently have negative interest rates. However, the base rate set by the Bank of England is only 0.75%. Back in the 1990s, rates were as high as 10%, before falling over the past decades.

Low interest rates mean that you are getting paid less for holding your cash in the bank. The economists reading this will note that this is not a bad thing, the concept is that low interest rates force people to go out and spend their money due to the low returns, helping to boost demand and get the overall economy motoring along.

But for cash holders, low interest rates are bad. So how can you generate higher returns than currently offered by a savings account or a Cash ISA?

Dividend-paying stocks

In some ways, a stock that pays a dividend can be likened to receiving an interest payment from your invested funds. For example, let us say you invest £1,000 into a FTSE 100 company that pays a dividend of £40 a year. This is a dividend yield of 4%. 

Already you can see that this is a higher return than the 0.75% base rate. Here is a key point that you need to know — higher returns often mean higher risk. While money in a Cash ISA generates lower returns, your capital is protected. With a dividend-paying stock, the dividend yield can be high, but you are risking your capital, which could decrease if the share price falls.

Therefore, while I definitely recommend buying high-dividend-yield stocks in order to generate higher returns on the amount you invest, be careful. Do your research and pick stocks that you fundamentally believe in. There is no point picking up high dividends if this is wiped out by the loss on your capital.

Stocks versus other assets

Some investors buy gold when interest rates are low. Their reasoning is that the opportunity cost of owning gold (which pays no interest) is lower when you can only pick up max 0.75% from your cash or savings accounts. However you can get exposure to gold while still picking up some form of income. For example, you could buy shares in a mining company that focuses on gold. 

You pick up the dividend from the company, and if the price of gold rises, then the share price of the company will likely rise too. This way you continue to get the benefit from wanting to invest in a particular asset (this could be gold, oil, property etc), but retain the potentially lucrative dividend payments.

Overall, low interest rates can be a pain, but be smart in allocating your funds and you do not have to suffer unduly.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jonathan Smith has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »