April 2022

Most of us intuitively know that the wider UK economy affects investment returns. Interest rates, for instance, are set by the Bank of England (BoE) and can affect the stock market – providing downward pressure if rates go up (as ‘less- risk’ is perceived for higher short-term returns) and providing buoyancy when rates are lowered. One interesting relationship between investment returns and the economy concerns unemployment. For instance, does it help – or hinder – the stock market if more people are in stable, paid work? Below, our financial planning team at WMM offers some reflections.

How unemployment affects the economy

It is, firstly, important to define what unemployment is and how it is measured. Broadly speaking, unemployment refers to the percentage of a workforce that is actively looking for paid work – but unable to find it. Already, this raises questions. In particular, how do you determine whether someone without a job is looking for one? After all, many people are highly employable but might want a “career break” (e.g. 1-2 years) before trying something new.

The UK government defines unemployment as “The number of unemployed people divided by the economically active population”. This is based on the Labour Force Survey which asks 40,000 households every month about their employment status. To count as an “unemployed” person, a jobless interviewee must state that either:

• They have found a new job which they plan to start within the next 2 weeks. Or;
• They have looked for work in the last 4 weeks and can start work in the next 2 weeks.

Generally, the UK government seeks to keep unemployment as low as possible. This is partly for political reasons, so they can boast about their record (particularly in the run-up to elections). However, it is also for economic reasons. For instance, more people in paid work means more wages that can be taxed – providing more revenue for the treasury.

Unemployment and investments

Fewer people in work means less money coming to the government, and perhaps more going out (in the form of state benefits). Yet unemployment also means less money for people to go out and spend on products/services offered by businesses. This means less sales and lower profits, which applies downward pressure to growth and, by extension, company valuations (unwelcome news for shareholders).

In an economy with high unemployment, even those with jobs are often less likely to spend money. After all, job security seems less certain in such an environment – so people tend to save more in case they come upon hard times. This is partly the reason why the UK national savings rate rose so much higher after COVID-19 hit the UK, since many people feared that their job might not be there when lockdown was lifted (although lockdown, itself, prevented spending in the wider economy – e.g. on the high street).

At this point, investors may rightly ask: “What is the state of UK employment right now, and where could things go in the near future?” Currently, employment is standing very high (in historical terms) at 75.6%. This is not quite the high of March 2020 (when it was 76.6%), but figures are not far off. This is good news for the stock market, although other forces – such as rising UK inflation – are pulling equities in other directions. 

The future, of course, is uncertain. Whilst the UK appears to be on a journey of economic recovery from COVID-19, events could undermine efforts to build on this. A new variant may arrive – bringing a return to lockdown. Wars can also disrupt the global economy and unsettle markets. Here at WMM, we are here to help guide your financial decisions and build in greater security when events – such as a job loss or damage in the wider economy – might affect your financial plan. 

Invitation

Interested in finding out how we can optimise your financial plan and investment strategy? Get in touch today to arrange a free, no-commitment consultation with a member of our team here at WMM. 

You can call us on 01869 331469 

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxfordshire).

Have you wondered what it might be like to “be the bank”, when lending money? With bonds, you can do just that. In effect, when you buy a bond, you lend to a Government (or business) on the understanding that they will repay you at the maturity date (e.g. in 10 years’ time). In the meantime, you receive interest payments (“coupons”) periodically – say, once every 6 months. 

For many investors, this asset class is an attractive option when building a portfolio. Yet what are the different types of bonds, and how do they work? How can bonds feature within a wider investment strategy? Let’s turn to these questions below.

Types of bonds

Bonds can be divided into various different categories. First of all, there is, of course, a lending risk for the investor which may be lower/greater depending on who is asking for the money. This is where credit agencies come in – such as Standard & Poor’s (S&P), Moody’s Investor Services (Moody’s), and Fitch IBCA (Fitch). These companies “rate” different bond issuers to indicate the level of risk involved for investors. For instance, a “AAA” rating is considered the best, whilst “C” rated bonds are regarded as higher risk (and so are often called “junk” bonds”).

Secondly, bond issuers can be divided into corporate and governmental. The former are issued by companies and the latter by national governments. Neither is inherently more risky than the other. Indeed, certain companies may have a better bond repayment track record than many governments! The major difference is that Governments can print money or raise taxes to repay debt, whereas Corporates cannot. Bonds can be bought individually by investors or collectively, via bond funds. Most retail investors will purchase the latter when including bonds in a portfolio.

Finally, bonds can be classed either as “normal” or “inflation-linked”. An illustrative example can help show the differences, here. With the former, suppose you bought a 30-year bond in 1998 for £100, with a 5% coupon (paid twice per year). In 2028, when the bond matures, you will get your £100 back and, twice per year in the interim, you get a fixed £5 coupon. However, with an inflation-linked bond, differences would include the coupon rate (i.e. it would be lower) and the semi-annual coupons would rise/fall with the rate of inflation. When you get the principal back in 2028, moreover, this will also rise with inflation so you get your £100 back, in “real value”).

Bonds & investment strategy

These features raise a number of additional questions for investors. What percentage of your portfolio should comprise bonds (versus, say, equities)? Which types of bonds should you put inside? Here, two crucial factors are your risk tolerance and your investment horizon.

Concerning the former, if you feel highly averse to the idea of your investments going up and down a lot in a short period of time, then bonds can hold a lot of appeal. Whilst stock market investments tend to offer better (i.e. higher) long-term returns, they are often volatile in the short term. Bonds tend to be much more stable in the short-term. 

On the latter, you need to consider how long you plan to invest (and how this relates to your goals). For instance, if you are nearing retirement then you likely want to focus more on wealth preservation rather than growth. Moreover, you may also want some of your portfolio to produce a regular income. In which case, bonds can be an attractive option. However, if you are early in your career and want to build wealth over, say, 30+ years then holding lots of your portfolio in bonds may not be a “bold” enough investment strategy. Instead, high-growth-potential equities may be a better route to reach your goals (assuming you are happy with the risk involved).

Invitation

Interested in finding out how we can optimise your financial plan and investment strategy? Get in touch today to arrange a free, no-commitment consultation with a member of our team here at WMM. 

You can call us on 01869 331469 

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxfordshire).