Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

It’s the beginning of a new year and that means the unveiling of our latest Investment Outlook. This week, Tom Stevenson, Outlook author and Ed Monk, associate director at Fidelity International answered your questions.

Like last year, interest rates continue to capture the attention of investors. Fidelity customers were particularly curious about whether this ‘higher for longer’ environment may be a deterrent to investing in the market. Tom said he wasn’t surprised that a few questions asked this.

Beyond interest rates, the outlook for bonds in 2024 was a popular topic. That’s because bonds have disappointed investors for over a year now. Still, interest in bonds has not waned and Tom points to a slightly more upbeat tune for this asset class.

The case for ISAs versus pensions was also explored. Of course, there were a whole host of other intellectually stimulating conversations - the story in China which has left investors feeling unsure about the future of the global superpower. And all eyes were on the US, where one customer was curious about the upcoming US election - which will no doubt come by quick and fast.

You can watch the Investment Outlook Q&A below. For now, here are three key questions to dig into:

1. A two-year fixed rate cash bond will pay 5%. Why invest in the market at all when interest rates are relatively high?

With interest rates where they are the moment, this is the first time in many years where people have had a real choice in terms of asset allocation. That’s because they can achieve a decent income from more than one source.

“So, why would they bother with the market? Well, look at what’s happened over the 12 months. As we saw in 2023, the stock market had a very strong year,” said Tom.

“While at the beginning of the year a 5% return on cash might have seemed quite attractive, by the end of the year, the S&P 500 Index was up 26%, including dividend income. So, it massively outperformed everything else - including bonds and certainly cash.”

Ed added that even though cash rates began to look much better when interest rates rose, they were still lagging inflation. Now, cash accounts are paying slightly more than the rate of inflation but history suggests this won’t stick around for long.

However, it does depend on what you want from your money.

“It’s about your risk tolerance and the time scale you’re talking about. If you’re investing for a couple of years and you can secure a 5% income on your cash, that’s attractive. If you’re investing over a 20 or a 30-year period, then you need to think about the long-term returns from asset classes. “

It’s also worth touching on the cash savings market right now.

“At the moment, that 5% return may be the best you can get. It’s available on instant cash savings accounts and if you lock it in for one year but two-year, three-year fixed-rate accounts are paying less than that,” said Ed.

Tom said that this is telling us that the market expects interest rates to come down.

It’s a similar story in the mortgage market, where they factor in expectations about the direction of rates.

“I think that there is widespread acceptance that interest rates have probably peaked in the current cycle. We don’t know how fast they’re going to come down or when they’re going to start coming down. I think that most people think it will be lower in a year’s time than they are now.”

2. What is the outlook for bonds in 2024? And can we predict when the losses from 2022 will be offset?

Tom mentioned that this question was asked last year and his answer said something along the lines of - “well, we’re heading towards a recession, and central banks are going to cut interest rates in due course, in response to that recession. And it will probably be good for bonds.”

“That wasn’t the best thing to say about bonds last year but I suspect it might be the correct thing to say this time around.”

“In some ways I think as we go into 2024, we may well get everything we thought we’d get a year ago but didn’t. We were surprised last year. Our base case is that the highest probability is attached to a mild recession. Central banks have indicated that they will be cutting interest rates but not as much as the markets are expecting. So, the Federal Reserve has indicated maybe three-quarter point interest rate cuts, this year. The market is factoring five or six. Either way, that will be good for bond prices.”

Ed highlights that there is a difference between what central banks say and markets think.

“The market has been more dovish. There’s a reason for that - central banks have the job of dampening down exuberance on this sort of case. Yes, we know that rate cuts are coming but they don’t want the market to get ahead of itself. And they want to take inflation out of the economy, and they can do that with words, as well as actual rate rises or high borrowing costs. So, they will talk a tough game, that’s what they’re naturally inclined to do and so its perhaps to be expected that they are more hawkish than the markets.”

Tom agreed and said it was in the central bank’s interest to talk a harder game than maybe the markets are expecting.

“The market’s job is to simply predict what they think is likely going to happen. The reality is it is somewhere in between the two. It’s probably closer to where markets are than what the Fed is saying.”

3. A friend of mine is a self-employed basic rate taxpayer. They’re paying £450 a month into a pension. But without the benefit of employer contribution, it seems to me that the flexibility of a low-cost stocks and shares ISA might be better. They don’t plan to use tax-free cash. And in their position and in order to achieve a transparent return with flexibility, wouldn’t an investment be better than a pension?

“This self-employed person is a basic rate taxpayer and they’re saving £450 a month. It sounds like they’re saving quite a high proportion of their income which is a good and prudent thing to do, so well done. I think that the flexibility question is interesting because as the question says they don’t have intention to use tax-free cash. Well. we don’t know what we’re going to do in the future. And I think that the tax-free cash element of the pension equation is one of the great flexibilities of pensions. Because 25% tax-free as the legislation stands for at the moment, is a pretty useful bit of flexibility,” said Tom.

Ed emphasised that there is a difference between ISAs and pensions in terms of tax benefits.

An ISA can be used to save for all sorts of goals as it's easy to access, while a Self-Invested Personal Pension (SIPP) is typically for retirement, as withdrawals from a SIPP will not normally be possible until you reach age 55 (57 from 2028).

“The 25% tax free cash is the thing that tips it in favour of a pension. Even if you don’t plan to use the tax-free cash, you still want the benefit of it. Whether it’s available as a lump sum or you take lump sums from your pension, you still get the benefit of the 25% tax-free cash.”

Tom said that there is an argument for having both an ISA and pension. Read more about ISAs and SIPPs here.

Watch the full Q&A below

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Please be aware that past performance is not a reliable guide indicator of future returns. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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