Hikes in interest rates always have a way of shaking up the investment landscape. As at the time of writing, November 2026, rates in the UK are 4%, the US has a target range of 3.75% to 4%, and the ECB is at 2.5%. Policy rates vary considerably elsewhere, including 4.85% in Australia and 0% in Switzerland.
When interest rates are increased and/or high, you face an important question: Why accept the uncertainty of equity markets when cash deposits and government bonds may offer attractive yields without requiring the same exposure to equity market risk?
During much of the 2010s, interest rates remained exceptionally low across many developed economies, resulting in comparatively modest yields on cash deposits and newly issued government bonds. Subsequent increases in interest rates have made these investments appear more attractive, prompting many people to reconsider whether the potential returns from equities adequately compensate for the additional risk.
However, government bonds carry their own risks, as demonstrated by the weakness seen across bond markets during previous periods of sharply rising interest rates.
Attractive yields alone therefore provide an incomplete basis for investment decisions. Inflation, interest-rate sensitivity, investment timescales and the potential for longer-term growth all influence the suitability of different asset classes.
Government bonds are often regarded as lower-risk investments, particularly when issued by ‘financially stable’ governments. However, their market values can fluctuate considerably, and higher yields do not eliminate the possibility of investment losses.
A conventional fixed-rate government bond pays predetermined interest, known as its “coupon”, and repays its face value at maturity, provided the issuer meets its obligations. Its “yield to maturity” reflects the purchase price, remaining interest payments and redemption value, assuming the bond is held until maturity.
Despite the relative predictability of these contractual payments, government bonds remain exposed to several investment risks:
Cash deposits provide interest income, whilst government bonds offer contractual payments and can contribute to portfolio diversification. However, neither provides direct participation in corporate earnings growth.
Equities, by contrast, represent ownership in businesses, allowing you to participate in corporate earnings growth through dividends and capital appreciation. However, neither income nor capital growth is guaranteed, and share prices can experience substantial fluctuations.
Historically, diversified equity markets have delivered higher long-term returns than government bonds and cash, although this has been accompanied by greater volatility and periods of significant losses.
An increased allocation to cash and government bonds may therefore involve an opportunity cost. Although higher yields can make these investments more appealing, holding a substantial proportion of capital in them may limit the potential for long-term portfolio growth.
The length of time before capital is required can significantly influence the appropriate balance between cash, government bonds and equities.
Reinvestment risk is also relevant when considering longer-term returns. For example, a 5-year government bond may provide contractual payments until maturity, but if prevailing interest rates have fallen by the time the proceeds become available, comparable investments may offer lower yields. Securing an attractive yield today does not guarantee that the same level of income can be maintained over an extended period.
However, a longer investment time-frame does not guarantee that equities will outperform government bonds. Investors must therefore continue to consider whether the potential for additional growth justifies the associated risk, taking account of their financial objectives and capacity for loss.
Whilst higher interest rates have increased the yields available from cash deposits and government bonds, it is often best to avoid placing too much emphasis on shorter-term market developments. The appropriate investment strategy will depend on individual circumstances, including proximity to retirement, income requirements, financial objectives and capacity for loss. For some, preserving capital and generating income may take priority, whilst others may have greater scope to pursue longer-term growth.
At Patterson Mills, we regularly review our clients’ investment portfolios to ensure they remain aligned with their financial objectives, taking account of changing market conditions and the relative risks and opportunities across different asset classes.
If you would like to review whether your investment arrangements remain appropriate for your financial objectives, get in touch with us today and book your initial, no-cost and no-obligation meeting.
Send us an e-mail to contactus@pattersonmills.com or call us direct at +44 (0) 1908 503 741 and we shall be pleased to assist you.
Please note that all content within this article has been prepared for information purposes only. This article does not constitute financial, legal, or tax advice. Always ensure you speak to a regulated Financial Adviser before making any financial decisions.
