Stephen Findlay is the CEO and founder of BondMason, the investment specialists in the direct lending market, helping clients target a gross return of 8% per year. He is a Fellow of the Institute of Chartered Accountants in England and Wales. With interest rates seemingly permanently in the doldrums, what are the options for business owners looking to protect cash balances and earn an extra return? Below, Findlay looks at the options:
With bank interest rates likely to remain lower than inflation the buying power of any money your business keeps in the bank is eroding over time.
According to recent research from specialist bank Aldermore as many as 3 million SMEs are not earning any interest on their commercial savings, while BondMason calculates that the past 10 years of low inflation will have cost a business around £1,930 for every £10,000 of cash it held over that period.
There are millions of small businesses that have money set aside. Maybe your business has cash set aside for a future tax bill, or you are building up a rainy-day fund? Whatever the reason you could be losing out if you aren’t using it to generate additional money for your business.
There are many options when it comes to making your business’s money work for you. The decision critically comes down to two key factors:
- liquidity – when and how quickly do you need access to the money; and
- risk – to what extent are you willing to put money into low or moderate risk investments to secure a better return?
Read on for an overview of how you could make your business’s money work harder:
- Bank deposit accounts
Having money in a bank account is a convenient place for keeping funds for short term commercial plans but as a place for keeping pots of money for the medium and long term they are unattractive.
Aldermore’s research found that of those SMEs earning interest on their savings just over half earned less than a measly £300. Rates remain low, about 0.5%, and inflation slices between 2 and 3 per cent off the value each year, which will have a bigger impact over time through compounding.
With bank deposits, typically, the higher the interest rates the more penalties you incur if you need to access your savings early. Some penalise by not paying out bonuses or taking away interest payments if you need to access your money early. Others may make a reduced payment.
None offer a great deal, particularly if you consider this: a bank may borrow from the capital markets at a rate of 5%+, yet you are giving it the money almost for free.
Indeed, it is costing you for the privilege. To illustrate; because of compounding when inflation is 2% above the bank rate, which it has been in recent years, then £20,000 deposited three years ago, in real purchasing power terms, will be worth £1,332 less now.
While bank deposits are low risk and carry some protection, they still carry “risk”, not just because they are constantly eroded by inflation, but also should the bank fold you will only get up to £85,000 back through the protection of the FSCS regulator, and this protection is not available to all limited companies.
- Fixed term bonds
Fixed term bonds, and/or fixed rate bonds, are longer term “debt papers” that usually come with a predetermined interest rate. While they often offer higher interest rates than regular bank accounts, investing in one may mean giving up access to your money during the term of the bond, although depending on the bond, and how it is structured, there may be an ability to sell the bonds before the end of their term. Nearly all bonds carry risk to capital.
For many businesses, bonds are attractive because interest rates are not dependent on the Bank of England. Typically, bonds can span a 1, 3, or 5 year time scales, and the longer you tie your money in the higher the rate of interest available.
Are there any downsides? It goes back to how much you are willing to put aside and what access you need to your money. If you need quick access to your money this may come with penalties or accepting a lower price in a secondary trade. There is also the risk that if the bond issuer becomes insolvent before the agreement ends then you could lose some of your money.
How you earn interest varies, so do check for this. In some cases you will receive it monthly as income, while in others you will only get it when the term of the bond ends.
- Stocks and shares
Alternatively, you can invest some of your business savings in shares in other companies, just as private investors can. You may also choose to invest in tracker funds, which is an approach recommended by Warren Buffet, one of the world’s most successful investors.
For businesses, as with private investors, the thing to remember is that the stock market goes up and down. Again, it is about time frame and attitude to risk.
Investing in stocks and shares is best viewed as a long-term strategy. The overall direction of developed stock markets is a rise in value over the very long term, punctuated by unpredictable falls.
Trying to second-guess the short-term impact of events such as Brexit or the recent stock market correction, is difficult to get right and rarely pays off.
- Peer-to-peer market
The peer-to-peer market, also referred to as ‘direct lending’ offers businesses an attractive alternative, delivering stable returns generally around 6 to 8%+ per year. For these reasons, it’s an increasingly popular option for a business looking to achieve attractive risk adjusted returns with lower volatility.
If you want a return of over 4% on your business’s savings, and don’t want to speculate on shares, then it is the only place you are likely to get such returns for your savings.
The market covers all sorts of areas, such as lending to inventors and start-ups, developers and to SMEs using their invoices as collateral. Essentially you invest your money into a platform that lends that money to borrowers. There are 100s of these platforms which range from large and established to new and unproven.
For instance, BondMason invests through over 33 such platforms, having carried out thorough reviews and due diligence on over 80. There are more launching all the time.
- Diversify across different lending partners
With the direct lending market, operational failure is a risk, so spreading your funds using several lending operators will mitigate this. Diversifying across different lending partners may also help to allocate your investment more efficiently. This is because different lending platforms have access to different loan opportunities.
- Diversify across different loan types
No single investment can be relied upon to produce safe, reliable and consistent returns. The benefits of a diversified investment portfolio apply to direct lending in the same way as any other portfolio. Spreading your investment across different loan types, loan durations and grades is an effective way to target good returns over the long term.
- Regulated v Unregulated
An important element to consider is whether an investment is regulated or not.
Regulation ensures many businesses and products have to conform to certain standards and processes, and this gives investors certain protections and compensation.
It is worth noting that the regulator does not advise on the quality of investments available, so you should bear in mind that just because a platform is FCA regulated, that doesn’t mean the quality of loans or returns are guaranteed; a regulated investment can still provide a poor return.
Many investments are categorised as unregulated, including property and most peer-to-peer and direct lending. For those looking for a good combination of higher return and acceptable risk, then there are plenty of unregulated investments from established and trustworthy providers that businesses can utilise for getting a better return on their savings.
Sadly, keeping your business’s savings in a deposit account means their value is constantly being eroded by inflation. It has been that way for 10 years now and that does not look set to change for the foreseeable future.
If you are looking to get back to the “good old days” where savings earned above inflation interest, then you are going to have to take on a little bit of risk, which can be mitigated by not having “all your eggs in one basket” and putting some of your savings into carefully selected unregulated bonds and peer-to-peer or direct lending opportunities may be the answer.