What caught my eye this week.

Another roughhousing in the markets. It’s enough to make you wish you’d pursued a gentler hobby. Maybe kickboxing.

The falls are now officially deep. Even British investors tracking their global returns in our ever-punier pounds have taken a foot to the face:

Presumably I won’t get readers telling me this time that I’m being spooked by phantom bears. Because the pain is finally spreading to all corners.

Okay, bully for you if you had more than my few percent in gold.

Indeed more growth-minded investors like me are frantically tapping the mat like we’re trying to drive nails into the ring with our bloodied hands.

Meanwhile I doubt there’s a professional developed market bond manager in business who has seen a market as bad as the past six months. (Apologies to any septuagenarian fixed income experts reading.)

Even value investors have not been unscathed. Lately they’ve found a puck coming in their direction can still smack them in the face. The cheap and stodgy FTSE 100 threw in the towel this week. It is now down nearly 7% for the year.

You’d still rather have been in value than growth of course, if you’re a naughty active sort.

The UK’s largest, growthiest – and until recently frothiest – investment trust Scottish Mortgage has fallen 46% year-to-date.

Warrior

Old hands might be expecting it’s around now that my gung-ho alter-ego will enter the ring, raise his fists, and urge that it’s a great time to buy – like in March of 2009 or 2020.

It could be. It’s certainly hard to imagine (non-UK) investors being much more bearish.

Alas Alter-Investor is still over in the corner, on the other side of the ropes, biting his gum shield.

Maybe I’ve just taken too much of a battering to feel bullish. (And yes, that could certainly be a contrarian cue.)

My portfolio has been battered for over a year. While I did pretty well to sidestep the first round of disruptive tech carnage in 2021 – swapping a fair bit of clearly over-valued growth companies into my old favs, UK equity income trusts – I got greedy too soon.

Back in December I was warning that the under-the-surface growth sell-off could well herald a wider crash. Yet as I noted then, I was already seeing apparent bargains in my beloved software, cloud, and consumer tech shares.

Slowly my income trusts mostly went back out the window for fast-growers down 30-60%.

Who doesn’t like a bargain?

Unfortunately it was time to learn again that a share that’s down 80% is one that fell 50% before you bought it – and which then dropped by another 60%.

I am astonished by how far some of these – growing, cash-generative – companies have fallen. That astonishment is smeared across my portfolio in red.

Rocky

The good news for me is that on the back of my concerns about imminent quantitative tightening earlier this year – and with an eye on my leverage – I acted in February to shift a huge proportion of my portfolio into a new bucket I call ‘low volatility fixed income’ on my infamous spreadsheet.

True, even that’s since fallen 4%. It’s a shame I didn’t just call it ‘cash’. But the move has saved my net worth from a deeper ravaging.

The only trouble is I don’t want that to sit around forever while inflation has its wicked way with it.

Remember my spin on investing risk and thermodynamics:

“Investing risk cannot be created or destroyed. It can only be transformed from one form of risk to another.”

Inflation risk is one concern. Opportunity cost – missing the rebound – is another.

That’s the trouble with any sort of strategic tactical allocation market timing.

First you have to get out without doing so at the bottom.

Then you have to get back in.

Fight Club

So yes, perhaps I’m punch drunk. Read me accordingly.

Certainly it isn’t time to sell, unless you’ve realized your asset allocation or risk tolerance is far out of whack. (Even then proceed cautiously).

You want to sell when everyone is chasing rainbows, not when grizzly old veteran investors like me are feeling under the cosh.

The market has front-run a lot of this regime change away from free money – hence the turmoil. But the falls so far are hardly historic, and in the US especially they’re from extreme valuation highs.

Moreover the impact has only just begun to be felt in the real world of mortgage rates, company earnings, and that ultimate lagging indicator – jobs.

I haven’t learned my lesson, and I believe there are opportunities in the decimated growth sector.

But away from those on-the-ropes stocks, I feel there could be more of a kicking to come.

Creed

However you invest – passively or actively – this is a Joel Edgerton market where you want to roll with the punches, not a Tom Hardy one where you want to risk all for knock-out glory.

Try that and it could well come back to smack you in the face.

Here’s live footage of Mr Market in 2022 versus yesteryear’s everything-goes-up lockdown traders:

It’s been a rough six months for most of us – but it will pass.

Go for a walk. Stay invested. Add new money. Check your household budget as the economic squeeze intensifies.

And have a great weekend!

[continue reading…]

The Vanguard LifeStrategy funds are excellent if you want to put your money to work in a quality investment that you can leave to grow over time.

These funds are easy to understand, need minimal maintenance, and should perform well over the long term. There are no worries about constantly having to manage it.

Vanguard LifeStrategy funds are like the iPads of investing. They take a product category that was overly complex and made it super-simple for anyone. All while still delivering good results. 

Think there must be a catch – such as that LifeStrategy funds are sub-standard? You’re dead wrong.

The truth about investing is you can achieve life-changing results just by getting the basics right:

• Diversify across the global equity markets.
• Mix your risky equities with high-quality bonds for additional diversification.
• Choose a low-cost fund. This way your money fattens your balance not some fund manager’s.
• Choose passive investing for a great balance of results, simplicity, and best practice.

The Vanguard LifeStrategy funds tick all of these boxes. 

What are Vanguard LifeStrategy funds?

Vanguard LifeStrategy funds belong to an investment category known as multi-asset funds. 

Multi-asset products bundle multiple asset classes into a single package. It’s a convenient format that contrasts with the majority of funds that specialise in a single market. 

Traditionally, you’d construct a portfolio from several individual funds. Each would be invested in a particular market. 

For example, you’d choose one fund for UK shares1. Another for emerging markets. Yet another for government bonds, and so on. 

But LifeStrategy funds do away with all that. Instead they invest across global equity and bond markets in a one-er.

It’s like buying a multi-pack of crisps. Except this bumper deal enables you to scoop the major investment flavours in one easy purchase. 

This is known as a fund-of-funds approach. That’s because a Vanguard LifeStrategy fund nests several index funds inside it. 

Each nested fund ensures you’re covering a major market. For example here are the individual funds that the Vanguard LifeStrategy 60 fund automatically invests in for you:

Those underlying funds amount to an instant portfolio. Et voila! You’re now diversified around the world in thousands of shares and bonds. But instead of you doing the work, Vanguard did it for you.

Who is Vanguard?

Vanguard has grown to become one of the biggest asset managers in the world. It is famous for index funds and driving down investment costs on behalf of consumers.

Vanguard was founded in 1975 the US by the late John Bogle. Bogle was a visionary. His mission was to offer a better deal to investors and disrupt the fund industry.

It took decades, but Bogle ultimately won the argument. Vanguard’s success forced competitors to respond with their own ranges of cheap index funds and ETFs.

When Vanguard arrived in the UK in 2009 it repeated the trick.

UK investors have enjoyed a cheaper and wider range of investment products ever since. Index tracking funds continue to take market share from the traditional fund industry.

Which Vanguard LifeStrategy fund?

There are five LifeStrategy funds in the range. How do you pick one?

The key difference between the funds is their asset allocation split between equities and bonds. 

Here’s the strategic asset allocation for each Vanguard LifeStrategy fund:

Fund name	Equity allocation	Bond allocation
LifeStrategy 20 Equity Fund	20%	80%
LifeStrategy 40 Equity Fund	40%	60%
LifeStrategy 60 Equity Fund	60%	40%
LifeStrategy 80 Equity Fund	80%	20%
LifeStrategy 100 Equity Fund	100%	0%

At one end is LifeStrategy 100. It’s purely invested in equities.

LifeStrategy 20 is at the other end. It is 20% allocated to equities, with the rest in bonds.

The rule of thumb is: 

The higher the percentage of equities in a Vanguard LifeStrategy fund, the better its prospects for growing your wealth in the long-term. 

Equities have historically been the best performing asset class over most periods of at least ten years. 

But there’s a trade-off. Equity-dominated portfolios are riskier. They’re prone to falling harder and faster during stock market crashes and bear markets.  

The role of bonds in a portfolio is to take the edge off such stock market slumps. 

Bonds have historically earned less than equities over the long-term. But they’re typically less risky in the short-term. That’s because bonds can weather recessions better than equities. 

Bonds may even rise in value during a stock market crisis. 

Think of equities as wealth rocket-boosters that are prone to misfire. 

Bonds can act as parachutes that soften the landing.

However, they don’t always work. And their extra weight slows down your rocket ship a little over time. 

In short, picking the right Vanguard LifeStrategy fund means balancing the amount of growth you need versus the risk level you’re comfortable with.

Choosing more equities means exposing yourself to more risk in the hope of greater gains.  

Expected equity/bond portfolio behaviour

Here’s how Vanguard illustrates the risk vs reward compromise using historical UK returns:

Notice that the average annualised return increases as you hold more equities. But the downside risk is also more severe.

The minus number reveals the worst return each portfolio suffered in a single calendar year from 1901-2020. 

This encapsulates the expected behaviour of the different Vanguard LifeStrategy funds. 

You can’t expect a repetition of those precise numbers. But you can expect the LifeStrategy 20 fund to suffer less than riskier, equity-heavier versions in downturns. (Not always, not all the time. But that’s the historical trend.)

Conversely, the Vanguard LifeStrategy 100 is likely to deliver the best returns over the decades. (No guarantees, mind.) Yet watching 50% of your wealth vaporise in a year can be a sickening experience. And this is almost certain to happen at some point. 

The risk is that you then panic. You sell up and lock in your losses. Or you lose a large amount of money just before you need it and don’t have time to wait for a bear market recovery. 

That’s why choosing a LifeStrategy 100 or even a LifeStrategy 80 fund based on long-term performance is not a no-brainer. They’re too risky for some people.

Which is the best Vanguard LifeStrategy fund for me?

The best Vanguard Lifestrategy fund depends on your attitude to risk and need for growth.

The less growth you require to achieve your financial goals, the less point there is taking on the risk inherent in a 100% equities portfolio. 

How much growth do you need? Work that out using our guide to creating an investment plan based on your circumstances.

If you dream of financial independence then try this walkthrough on how to achieve FI.

We can also help you answer the question: “How much do I need to retire?”

To understand more about handling risk, you should read our primer about risk tolerance.

Many people though can’t find the time to make a plan or get to grips with their risk tolerance. Or they discover it’d be easier to nail jelly to a wall.

Instead, you can substitute rules of thumb for a proper plan – at least to get started.

One of the best known rules of thumb suggests you choose your equity allocation like this:

110 minus your age = your equity holding

You can then round up or down to the nearest Vanguard LifeStrategy fund.

Potentially you can even blend Vanguard LifeStrategy funds. Take your equity allocation to 50% or 70% or whatever you prefer.

Rule of thumb assumptions

The rule of thumb above assumes young people can afford to take more risk than older investors.

That’s because young ‘uns have more working years to recover from a stock market crash. And they’ve less wealth on the line in the first place.

But while that’s broadly true, every individual is different. 

Ultimately, it’s best to choose a fund in line with your risk tolerance. Because even seasoned investors can find stock market crashes very hard to handle.

Know though that the industry default position is a 60/40 equity/bond asset allocation. That equates to the LifeStrategy 60 fund.

As you close in on your goal, you can mitigate the danger of a stock market crash by transferring from riskier funds into the less volatile LifeStrategy 40 or LifeStrategy 20 fund.

It’s definitely time to consider doing so once a big financial objective (such as retirement) lies within seven years.

Vanguard LifeStrategy performance

Compare the Vanguard LifeStrategy performance below. The graph shows you the cumulative return for every fund in the range since launch in 2011:

Source: Trustnet. Dividends reinvested. The table shows nominal annualised returns.

As a passive investing product, Vanguard LifeStrategy returns are in line with stock market performance and your bond allocation.

Over the last 11 years, you’d be happy with your choice.

Perhaps you’d be less stoked about results over the last year. But that’s not a problem confined to the LifeStrategy range. 

Equity and bond markets have had a terrible 2022. This happens occasionally. It’s why investing is said to be risky. Sometimes nothing seems to work.

But given time, world markets recover. Batten down the hatches, ride out the storm, and a diversified portfolio like Vanguard LifeStrategy should deliver over longer periods.

And, as you can see above, the actual performance of the LifeStrategy funds over the past decade or so does resemble the historical illustration we looked at earlier in the piece.

Vanguard LifeStrategy 100 leads the pack, followed by 80, with LifeStrategy 20 bring up the rear.

Vanguard LifeStrategy fund performance in a recession

Where the bond-orientated funds will often show their mettle is in a crash.

Look at the plunge that happened a few months before the June 2020 line in the graph below. You’re seeing the gouge torn out of the markets by the pandemic. 

Markets recovered in record speed that time due to massive government intervention. 

But the crash still illustrates why bonds can be useful. 

Because we can see how the usual LifeStrategy pecking order was completely reversed:

Investors anticipated the mother of all recessions, so they sold down shares. Hence the Vanguard LifeStrategy 20 performed best. Meanwhile the LifeStrategy 100 cratered over 25%.

Granted, the LifeStrategy 20 did still fall nearly 10%. But its large bond allocation acted as a counterbalance to out-of-favour equities. And it rebounded faster than the others, too. 

The other LifeStrategy funds dropped progressively more, in relation to bond allocation. 

It didn’t matter much in 2020. Because as I said it proved to be the shortest bear market of all time!

However the defensive qualities of bonds could have played a more useful role if the slump lasted years. That does happen.

Nothing is guaranteed

Sadly, bonds don’t always ride to the rescue. High inflation is particularly toxic for bonds and equities.

Both can plummet like Holmes and Moriarty at the Reichenbach Falls when inflation spirals.

That’s what’s happened in 2022. And it’s been bad news for the bond-heavy LifeStrategy funds:

The purple line of the LifeStrategy 100 fell furthest in February and much of March. Just as you’d expect when stock markets come under pressure. 

But from April, the hierarchy inverted. Since May the funds have buckled in proportion to their bond holdings. LifeStrategy 20 has actually done worst. 

This is an unusual situation, though not unprecedented. Markets are capricious. Sometimes investing reality doesn’t match expectation.

Vanguard LifeStrategy performance charts: what they don’t tell us

Performance charts contain helpful lessons. However they are a bad way to choose between funds.

It’s a hard fact for new (and indeed old) investors to accept. But it is true:

• You do not have the ability to predict which investments will outperform in the future.
• Past performance charts do not contain predictive data. This is stated in all fund literature.
• You can pay someone else to predict the future. But they will probably either overestimate their ability, or else charge you so dearly that you’re actually worse off anyway.
• In many cases they overestimate their ability and charge you dearly. This eats up your profits.

Passive investing products have surged in popularity over the past decade. That’s because the evidence is overwhelming that most people are better off with a passive strategy.

Though past fund performance is not relevant, historic asset class returns do matter.

You can expect a highly-diversified portfolio of equities to outperform bonds and bonds to outperform cash, over the long term. Otherwise, investors would not invest in riskier assets.

Equity returns are your reward for taking the risk that for some years – even decades in extreme cases – equities underperform bonds and cash.

The following three articles explain why you should ignore past performance as a variable, and be wary of anyone’s claims about investing skill:

• You have no investing edge.
• Why passive investing wins.
• Don’t study past performance.

Vanguard LifeStrategy portfolio

To check the portfolio of each Vanguard LifeStrategy fund you can go to its home page. 

Here’s the full line-up.

Once you’re on your fund’s page, tap on the Portfolio Data tab. 

Now you can see every individual index fund that comprises your LifeStrategy’s portfolio. 

However to save you time, below we’ve plucked out Vanguard’s breakdown of the underlying asset classes held in each portfolio.

(The bond duration data is from Morningstar.)

The Vanguard LifeStrategy 100 portfolio

• 100% equities, 0% bonds
• Bond duration: No bonds, so not applicable
  

The Vanguard LifeStrategy 80 portfolio

• 80% equities, 20% bonds
• Bond duration: 8.92

The Vanguard LifeStrategy 60 portfolio

• 60% equities, 40% bonds
• Bond duration: 8.98

The Vanguard LifeStrategy 40 portfolio

• 40% equities, 60% bonds
• Bond duration: 9.02

The Vanguard LifeStrategy 20 portfolio

• 20% equities, 80% bonds
• Bond duration: 9.01

What are the Vanguard LifeStrategy fees? 

Vanguard LifeStrategy fees range from 0.24% to 0.30% depending on the fund in question. 

The Ongoing Charge Figure (OCF) of all Vanguard LifeStrategy funds is currently 0.22%. 

Next we must add the (tiny) transaction costs. They vary by fund. 

• LifeStrategy 100: 0.02% (transactions) + 0.22% (OCF) = 0.24% total
  
• LifeStrategy 80: 0.04% (transactions) + 0.22% (OCF) = 0.26% total
  
• LifeStrategy 60: 0.06% (transactions) + 0.22% (OCF) = 0.28% total
  
• LifeStrategy 40: 0.06% (transactions) + 0.22% (OCF) = 0.28% total
  
• LifeStrategy 20: 0.08% (transactions) + 0.22% (OCF) = 0.3% total
  

What does that total cost percentage mean?

Let’s say your total costs are 0.28%. Essentially, you pay Vanguard £2.80 annually to manage your fund for every £1,000 you have in it.

That’s highly competitive. You can compare it against similar funds by tracking down their OCFs and transaction costs. 

Both numbers can be found in the Fees And Expenses section of each fund’s Morningstar page.

Some managers refer to the Total Expense Ratio (TER). That is broadly comparable with the OCF.

Ignore references to Annual Management Charges (AMCs). These exclude important costs and are misleading.

Best way to buy Vanguard LifeStrategy funds

You can buy and sell Vanguard LifeStrategy funds through Vanguard or through other financial platforms. See our broker comparison table.

Currently, investing directly with Vanguard is the cheapest option if you’re just starting out:

Investing in a Stocks and Shares ISA

• Use Vanguard if your fund portfolio is less than around £40,000.
• Check out Lloyds Bank Share Dealing if your fund portfolio is worth more than £40,000.

Investing in a SIPP

• Use Vanguard if your fund portfolio is less than around £125,000.
• Check out Interactive Investor if your fund portfolio is worth more than £125,000.

Simply choose your platform, set up a direct debit, and then employ your platform’s regular investment tools to automate your investing.

Vanguard LifeStrategy: the good

You get a low-cost, globally diversified, passive investment product in one simple package. It’s an off-the-shelf portfolio that’s extremely low maintenance.

Vanguard automatically rebalances your holdings daily. This helps control risk. And it saves you the time and cost of doing it yourself.

Each LifeStrategy fund’s asset allocation is clearly fixed between equities and bonds.

In contrast rival multi-asset funds typically allow asset class exposure to float over a wide range. That means you don’t really know what you’re getting.

Vanguard is FCA-authorised. The LifeStrategy funds are UK domiciled, so they benefit from the UK’s FSCS investor compensation scheme.

Vanguard LifeStrategy: the bad

The funds hold more UK equities than investing theory suggests is optimal. This skew is called ‘home bias’. It typically exists because people like holding shares in firms from their own country.

The LifeStrategy prospectus states that the UK stock market typically accounts for 25% of each fund’s equity allocation. You’d expect around 4% UK in a global index fund free of home bias.

Taken to extremes, this tendency can leave investors under diversified. But Vanguard hasn’t overdone it. It’s more of wrinkle than a rankle.

Another snag: if your fund is more than 60% invested in bonds and cash at any point during its accounting year then its distributions count as interest payments – not as dividends.

Interest payments are taxed at a higher rate than dividends. So beware if you hold LifeStrategy 20% (and potentially LifeStrategy 40%) outside of your ISA and SIPP tax shelters.

Note: this is a general issue with bond fund taxation. It’s not Vanguard-specific.

Vanguard LifeStrategy: the indifferent

LifeStrategy funds do not invest directly in other asset classes like property and gold.

However, they do hold equities with exposure to these markets (for example, mining companies). And you can add other asset class funds to your portfolio later with specialist index trackers if you want.

Multi-asset funds like LifeStrategy work by holding individual funds within a single ‘fund-of-funds’ wrapper. It is slightly cheaper to hold the underlying funds separately. With LifeStrategy you pay a small OCF premium for the convenience of buying in bulk.

That said, your overall costs may still be cheaper with an all-in-one fund. You’re not paying dealing fees for trading and rebalancing multiple funds.

Either way, the time savings alone are well worth it.

Alternatives

See how rival funds-of-funds stack up.

Read more on the best global trackers.

Vanguard LifeStrategy ETFs exist but not on the London Stock Exchange. These products are multi-asset just like their fund counterparts. Intriguingly, they are free of home bias. 

You can buy the LifeStrategy ETFs if your platform enables you to trade ETFs on the German, Dutch, and Italian stock exchanges. 

Some financial advisors may also be able to offer home bias-free versions of LifeStrategy. They need to access the LifeStrategy MPS Global range. 

Finally, if you’re pondering the differences between the inc or acc versions, this accumulation vs income funds post should help.

Are Vanguard LifeStrategy funds good?

Vanguard LifeStrategy funds are a good investment if you need to invest money to achieve a major financial objective.

Think retirement, financial independence, and sending the kids to Uni in a decade or two.

Are they always best? No, you can always find a different investment which would have been amazing in retrospect. One year it’s crypto, the next it’s oil futures. 

But absent a crystal ball, you’re best off choosing a simple, passive, diversified portfolio that captures the growth of the world’s major markets. 

Vanguard LifeStrategy does that at a low cost. And you aren’t sacrificing much in the process.

The crucial decision is selecting which version best fits your financial objectives and risk tolerance. 

After that you can just review your LifeStrategy fund once a year, and learn a few simple portfolio management techniques that help control your risks as you age.

Take it steady,

The Accumulator

1. Also known as equities. [↩]

Posts

Another round of interest rate hikes from central banks. Another month that sees mortgage rates rise, too.

Which means a bigger monthly bill for anyone not on a fixed-rate mortgage – or whose deal expires.

Oh, and inflation is rocketing. It’s already above 9% and the Bank of England now foresees 11% by October.

All of which has gifted us a cost of living crisis.

Suddenly the pound in your pocket (or your fintech app) is like a heroine in a Jane Austen novel – pursued by suitors from all sides.

We haven’t had to think about rising interest rates or inflation like this for years.

Higher and higher

Many people were shocked by energy prices soaring in 2022, for example.

Fair enough, that inflationary surge came out of the blue.

But there’s no excuse with your mortgage. We’ve been on notice that quantitative tightening was coming. Six months of interest rate and inflation speculation – as well as huge moves in the underlying bond markets, if you’ve paid attention – means we can’t say we weren’t warned.

The good news is UK mortgage rates are still low. At least compared to history.

However we have seen mortgage rates rise well off the Mariana Trench-like lows of last year.

Back then banks were practically giving away money like they used to hand out free piggy-banks.

Not anymore. According to broker L&C, the average two-year rate has trebled since October:

“…the average lowest two-year fixed-rate in June came to 2.71% and the average five-year fixed-rate rose to 2.78% … up from the historic lows of October, when an average two-year fixed rate was 0.89% and an average five-year fixed rate was 1.05%.

Mortgage Solutions, June 2022

A big jump for sure. However it is comparing today’s rates with a freakish, short-lived low.

Looking at the last 20 years to the end of 2021 better puts the recent mortgage rate rise into perspective:

Source: Statista

As you can see, today’s mortgage rate levels only takes us back to where we were in 2014. And rates have been far higher before then.

Given this headroom for still-higher rates and the pace of recent hikes, it’s not too late to stress test your mortgage. You want to find out how you’d cope if mortgage rates rise further.

For the rest of this article we’ll look at interest rate risk and your mortgage. Next week we’ll run through a checklist of other issues you might face with your borrowing.

Repayment risk: keeping up as mortgage rates rise

Most people today are on fixed-rate mortgages. In my view this is a good thing, compared to when more people were on constantly-fluctuating variable rates.

Everyone used to do a lot of opining back then about whether it was a good time to take out a fixed-rate mortgage versus some other kind of product. They’d try to predict where interest rates were going.

But there’s no good reason for the average Joe to be speculating on the direction of rates like that. We have multi-billion pound markets that struggle to get it right. You’ll probably do better only by luck.

This lack of edge isn’t the reason to go fixed-rate, though.

In fact it actually makes the case for choosing a mortgage that tracks the variable rate, perhaps with nice discount applied. That’s because in theory the market has already digested everyone’s best guess of future interest rate moves. So it should all be in today’s prices/yields.

And indeed, discount tracker mortgages that follow rates often do prove cheaper than fixed-rate mortgages over time.

No, the real reason to fix your mortgage is for certainty and budgeting.

A fixed rate is like an insurance policy. It takes the risk of higher rates off the table for as long as your fixed-rate mortgage deal lasts.

This means that if you can make your payments now, then provided your income and outgoings at least stay constant, you know you’ll be able to do so in the future.

When you have a massive liability like a mortgage tied to something as precious as your own home, that’s very reassuring.

How higher mortgage rates increase your payments

Alas, all deals come to an end. And when your current fix expires you’ll probably want a new fixed-rate deal, which is likely to be more expensive than the last one you took out.

First-time buyers obviously can’t lock-in the low rates of yesteryear, either.

So everyone will have to grapple with today’s rising rate environment.

And to belabour the obvious, these higher rates will mean higher monthly payments going out from your squeezed household budget.

Below are some examples of how monthly payments will ratchet up as mortgage rates rise. To illustrate I’ve assumed someone remortgaging with 20 years left to go:

Monthly mortgage payments at different interest rates

Balance, 20-year term	1%	2%	3%	4%	5%
£250,000 (repayment)	£1,156	£1,274	£1,400	£1,533	£1,671
£500,000 (repayment)	£2,309	£2,548	£2,801	£3,066	£3,343
£250,000 (interest-only)	£208	£417	£625	£833	£1,042
£500,000 (interest-only)	£417	£833	£1,250	£1,667	£2,083

Source: author’s maths

From the table we can see the magnitude of changes coming in people’s mortgage payments.

For example if you have a mortgage of £250,000 and you’re coming off a 2% fix, then at say 4% you’ll see your payments go up by £259 a month.

Of course you’ll have to do your own sums with a calculator to get your figures.

For my part, if I remortgaged today I’d guess my new fixed rate would be about 3.3%, judging by my lender’s current published rates.

That compares to the just-under 2% rate I’ve paid for the past few years.

A move from 2% to 3.3% doesn’t sound like much.

But with my interest-only mortgage it directly translates into monthly payments that are 65% higher.

Ouch!

The bright side of inflation

A 65% rise in monthly payments is ghastly from a sticker shock perspective, but I think I can take it. I also have a couple of years worth of payments set aside in cash as a back-up.

However if rates keep rising before I secure my next five-year term then it could start to get hairy.

(As with most fixed-rate deals, I would have to pay a small penalty in this final year of my term if I remortgage before it expires. I’d rather not!)

Higher rates stretch the case for staying invested versus repaying my debt, too.

How high would be too high? If the best five-year fix I could get was more than about double my current rate, I’d perhaps look to pay down the mortgage when my fixed term expires – or to take some other remedial action.

• Again, play with a mortgage calculator to stress test your own repayments.

The decision is not a no-brainer because inflation is running even more rampant than interest rates.

And that means today’s very high inflation is eroding the real terms value of our mortgages at quite a clip.

In fact if you’re paying 3% interest on a mortgage when inflation is running at 9%, then you’re kind of getting a real return of 6% on your debt!

In practice there’s more to think about. If your salary isn’t outpacing inflation or house prices go into reverse, you may not feel so lucky. And the ‘real return’ from a negative mortgage rate applies at a real terms net worth level. It’s obviously not actively reducing your nominal mortgage balance.

Also – crucially – you must be able to make your mortgage payments to benefit.

Repossession during a huge economic downturn is to be avoided at all costs!

So can you afford the higher payments?

Of course, simply seeing how your monthly payments are going to jump as mortgage rates rise doesn’t do much but give you heartburn.

You now need to take this figure and assess how it affects your overall household budget.

One way to do this is to calculate your interest cover figure. This is similar to how companies indicate their borrowing level to investors.

To do this you simply divide your monthly after-tax income by your monthly mortgage payments.

For instance, if you bring home £3,300 post-tax and your mortgage is set to cost £1,000 a month, you have an interest cover of 3.3x. That shows you could pay your mortgage more than three times over from your income, ignoring the other demands on your money.

However as that innocuous ‘ignoring’ suggests, I’m not sure how useful this figure will be for most.

You can perhaps compare your new coverage level to your current one to get a sense of how much more stretched you’ll be with higher payments.

But really, for individuals who occasionally take out a two-to-five-year fixed rate mortgage, it’s better to think in absolute terms rather than comparative ratios.

I’d simply plug your predicted higher monthly mortgage payments into your monthly budget if you have one – or into your best guess if you don’t.

What is left over after paying the mortgage and all your other bills? How much are you eating into your disposable income? (Will you still have any disposable income?)

The answer to these questions could warn you it’s time to tighten your belt.

If you want to get fancy, you could even model out the life of the mortgage term and inflate up your other spending to try to forecast a few years ahead.

If you do this, don’t forget that – hopefully – your take home pay should be increasing, too.

Longer-term interest rate risk: could mortgage rates rise to 10%?

The outlook for rates (and inflation, and the economy) is very uncertain.

The market seems to think rates and inflation will more or less settle down within the next couple of years. And that ultimately the wailing “awooga!” sirens will turn out to have been a temporary notice to take cover. As opposed to warning of a long-lasting stagflationary apocalypse.

However we’ve never before come off 5,000-year lows for interest rates. Let alone after a global pandemic. Never mind while a war rages in Europe.

So could we see interest rates head higher than expected? Mortgage rates of 6%? Or 8%?

It’s possible. But I do find it hard to envisage.

If mortgage rates rise much above 6% or so, many people could struggle. We might then see a wave of defaults, forced sales, a house price crash, and a vicious downward spiral.

At the same time the government would also face huge rises in the cost of repaying the national debt. Perhaps taxes would rise.

It all sounds deflationary – and likely to cause the Bank of England to cut rates.

That’s not to say it couldn’t happen. And I’m definitely not making a moral case for bailing out homeowners.

I just think it’s likelier that the Bank of England – and the UK Treasury – would lean towards accepting higher inflation versus triggering economic meltdown.

Indeed given the UK is carrying more than £2 trillion in national debt, many politicians might see chronic debt-eroding inflation as something of a happy outcome.

We are (probably) gonna make it

There are cataclysmic views out there as to how this all ends, but I’d keep some balance.

For instance since 2014, the Bank of England has mandated new borrower’s should face a stress test to see if they can still afford their mortgages if Bank Rate rises by 3% over a five-year period.

That’s one reason I believe we’ll escape a total meltdown as long as mortgage rates stay below 6%.

But who knows? All sorts of costs are rocketing and piling on the pressure, and there’s not much you or I can do about the big picture anyway.

Our challenge is navigate these choppy waters while preserving our future financial security.

How we save and invest is a big part of that, as is staying in the game as mortgage rate rise. So get stress-testing – and start to take some budgetary evasive action if you have to.

Next time I’ll go into more detail about my own stress test. Subscribe to ensure you get it.