The application of negative interest rates for certain clients on deposit has understandably struck a chord. But it’s possible this may be a force for good, if it’s the call to action that triggers investors to confront a decision they have been unwilling to make.
Confusing certainty for security
All investors should have immediate liquidity requirements addressed as part of their financial plan. Does cash provide certainty? Unequivocally yes. We are certain about the direction of deposit interest rates and that cash holdings will be negatively impacted. Does cash provide security? Unequivocally, no. The certainty of cash does not provide security against the real risk that investors face. And that risk is the real value of savings – the primary threat to which is inflation.
Defining risk as loss of purchasing power
We tend to think about money in nominal terms – euros and cents in our bank account. In the long run, the only rational definition of money is purchasing power. If my living costs double and my capital and interest thereon remain the same, I have effectively lost half my money. If money is purchasing power, risk becomes that which threatens it and security, that which preserves or enhances it. And this is the critical issue. We have grown up with the idea (misguided) that the primary risk of investing is the variability of our capital over short time horizons. Defined as such, then cash does seem low risk. Afterall, even with negative interest rates we can be fairly certain of what the value of a deposit will be six or twelve months from now. Defining risk, not as volatility, but as loss of purchasing power, changes the investment landscape completely. What is traditionally defined as low risk, cash and bonds, becomes high risk in this context (as they have historically provided minimal security from inflation). The assets that have protected us from long term real losses, (eg equities, real assets) are low risk in this context.
Don’t seek certainty, seek good advice
The default position of holding cash has always extracted a price in the form of opportunity cost. Now that decision is about to attract an explicit cost in the form of negative interest rates. Use this occasion to at least ask two questions; why am I holding cash and is the loss of purchasing power a more important risk metric than volatility?
If you have a genuinely long horizon with liquidity needs that are satisfied, and chose to manage uncertainty through holding cash, you are trying to slay the wrong dragon (volatility). There are many firms that will provide you with the certainty you seek. But if it is long-term security you need, then the foregoing has implications for you. Don’t seek certainty. Seek good advice.
If you are concerned about the impact of negative interest rates might have on your investments and would like to learn more about how we can help you turn a negative into a positive, contact Davy today on +353 1 614 3346 or visit davy.ie to schedule a call with one of our advisers.
The information contained in this article is for informational purposes only. It is not a recommendation or investment research and is classified as a marketing communication in accordance with the European Union (Markets in Financial Instruments) Regulations 2017. This document is not intended to be comprehensive or to constitute an offer or solicitation for the purchase or sale of any financial instruments, trading strategy, product or service and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. There may be some situations where it is advisable to hold cash. Your Davy adviser will make recommendations suitable to your individual circumstances.
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