Forecasting the Knock-On Effect of Cash Flow Changes

When looking at cash flow changes, it will soon become evident that short-term changes can significantly impact long-term wealth. Therefore, the ability to forecast cash flow for your clients is invaluable, identifying short-term issues to ensure they don't become long-term problems. While many people will dismiss the value of cash flow forecasts, they are an integral part of business and personal finances.

Over the last 30 or 40 years, we have seen considerable changes in interest rates and investment returns. Unfortunately, many people took the position that they would "come right in the end" when the situation did not rectify itself in many cases.

A shift in annuity rates

Annuity rates in the UK have turned significantly recently, rising from around 4.5% to 6.5% amid the government's disastrous mini-budget in September. This level of volatility in annuity rates will have a significant impact on long-term cash flow. Looking further back, annuities were compulsory for pension schemes in the 1980s and 90s before we saw the introduction of more pension freedoms. While rates had already been in decline as a consequence of increased life expectancy in the UK, the lack of demand also impacted returns. However, the situation is changing.

A recent article in the Financial Times highlighted that circa 1.8 million pre-retirees are now considering acquiring an annuity. It appears that 800,000 already had plans to look at annuities, while a further 1 million have been "persuaded" after recent economic and stock market volatility.

Interest on savings

As many of the so-called “baby boomers” enjoyed a significant increase in stock market investments and property during the 80s and 90s, interest from savings was a substantial income stream. Between 1970 and 1990, interest rates were constantly above 6%, peaking at 16% amid the Euro crisis. Fast forward to 2008, and interest rates fell below 1% in light of the US subprime mortgage crash. Consistently low for over a decade, they crashed to 0.1% in light of the Covid pandemic and are just now recovering.

The minimal interest rate on savings accounts in recent years, before the recent increase, has seen many savers experience a considerable reduction in their income. Keeping pace with inflation can be challenging, but falling behind in relative terms can significantly impact an individual's life in retirement.

Change in tax allowances

The value of personal and investment tax allowances should not be underestimated. The ability to lock in profits, avoiding capital gains tax, by utilising your capital gains tax allowance has been invaluable. Then we have the use of tax-efficient vehicles such as ISAs, which have also been an integral part of short, medium and long-term financial advice. However, only recently, the government announced plans to reduce the capital gains tax allowance to ￡6000, with a further reduction to ￡3000 in the pipeline.

While nothing has been confirmed, it has been widely reported that the Chancellor of the Exchequer is also under pressure to adjust ISA regulations. Speculation persists that he is considering a ￡100,000 cap on ISA investments or a reduction in the annual ISA allowance from ￡20,000 to ￡10,000. The fact that all assets held within an ISA are free from tax will have not only a short-term but also medium and long-term impact on cash flow.

Inflation

When looking at cash, it is vital to appreciate the relative value of money going forward, considering issues such as inflation. While, in hindsight, there may well have been signs of supply chain issues and energy price challenges, nobody expected inflation to hit double digits. Consequently, the relative value of money has eroded significantly in recent months. While there are signs that inflation is beginning to weaken globally, with the UK recently reporting a larger reduction than expected, it will remain historically high for some time.

While individuals and companies have no control over inflation, there are various assets they can consider as a hedge. Traditionally, gold has been the more recognised hedge against inflation in difficult economic times, but there are now other options. The alternative investment market is vast and takes in everything from property to whiskey, FinTech to renewables and more. As a result, more investors are now looking towards alternative investments as an integral part of their portfolio, giving a degree of balance.

Stress testing

Stress testing is critical to any cash flow forecasting process, taking in various scenarios. Before the 2008 US mortgage crisis and the subsequent Covid pandemic, Brexit and the cost of living situation, who would have forecast double-digit inflation in the UK and a base rate of 0.1%?

Wealth managers and financial advisers play a crucial role in alerting and keeping their customers abreast of market changes. As inflation continues to eat away at the relative spending power of individuals and companies, it is essential to monitor cash flow. Then we have the challenges of relative reductions in salaries which could have a knock-on effect on savings, investments and pension fund contributions. Unfortunately, due to the potential severity of the economic challenges facing the UK, we will likely see an increase in unemployment.

These scenarios can be stress tested with the aixigo cash flow planner, free to UK financial advisers.

Conclusion

Financial reporters won’t be short of subject matter in the future, from the 2008 US subprime mortgage crash to Covid and the cost of living crisis. While each issue in recent years could be described as a "one-off," they have all happened within a relatively short time of each other. This highlights the importance of cash flow forecasting, stress testing and looking at different scenarios. In hindsight, nobody could have guessed the economic, political and investment challenges of the last 15 years. In reality, these are potential scenarios which can be stress tested using the aixigo cash flow planner.