With deposit rates at zero or worse and government bonds also in negative territory in many cases it’s not a good time to be a safety-first investor. Traditional safe options have turned into sure guarantees of capital erosion. But savers and investors seeking growth still have options and they remain pretty much the same as they always were.
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This special report looks at how with deposit rates at zero or worse, and Government bonds also in negative territory, in many cases it’s not a good time to be a safety-first investor.
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The key is to invest in a well-balanced and diversified portfolio of assets and to have a clear understanding of any risks being taken.
“People need to be aware of the importance of having the right strategy and the right goals for their investments,” says Mercer private wealth leader Michael Lacey.
“It’s not just low rates of interest, it is negative rates. Over the last few years, it has been just about impossible to get a return without some risk. You can’t maintain capital value without an element of risk. People need to speak to good advisers who will guide them on the journey. Equities are where returns are going to be found but they do carry risk. As long as it’s a calculated risk and people are fully aware of it, that’s okay.”
He notes a change of mood in recent months. “Inflation hasn’t been a problem for the past six or seven years and it has only come to the fore in the last six months or so. But central banks are saying they want some inflation. If you want to get a return better than inflation you will need to take some risk. That means having a well-diversified, well-managed investment portfolio.”
The need to take some risk is not so much an issue for younger people, he adds. “They can take a very long-term view. But someone seven or eight years out from retirement needs to be thinking about de-risking to the extent that their fund will still deliver the required returns.”
And sitting around waiting for rates to rise again won’t help, according to Kevin Quinn, chief investment strategist at Bank of Ireland. “Interest rates on deposit are near zero for most deposits and for larger amounts are negative. And if you think that’s going to change any time soon, you will be disappointed. The message is simple: interest rates are going to be low for a long time to come. Right now, markets think it will be seven years before one-year deposits are positive.”
Inflation
Even after those seven years, inflation has to be taken into account. “Brewin Dolphin very much subscribes to the idea that we are not going to see positive-after-inflation interest rates for quite a while,” says Daniel Moroney, an investment strategist with Brewin Dolphin. “We’ve held that view for about a decade. With an inflation rate of 2 per cent, if people see an interest rate of 0.5 per cent there is an illusion that they are growing their savings or wealth.”
Private investors have to think about risk and what it means for them, he adds. “The investment industry tends to use blanket terms for risk and the most common is volatility. An asset class that is volatile is inherently risky. That’s absolutely true if you have a short-term time horizon. If you need the money for the deposit on a house or to buy a new car in the short term, volatile assets are very risky. If your investment is concentrated in one company that risk is amplified, and you can experience a permanent loss of capital. That’s an extreme example of risk.”
Old rules still apply in certain instances, however. “The things we used as a rule of thumb, that bonds and cash are safe and equities are risky, are still true in the short term. But it can actually be the reverse for investors with a longer-term time horizon. If you can identify a proportion of your savings that you won’t need to dip into for a five-, 10- or 20-year period you can look at afford to look at risk in a different way – as long as your investments are not too concentrated and not diversifying into low-quality investments. It still requires patience and forbearance to put up with periods of volatility.”
Davy chief investment officer Donough Kilmurray agrees, noting that a lot of people are sitting on cash waiting for interest rates to rise.
“They are actually taking a risk because their cash is losing value. People should split their capital into three pots. Money that you need for liquidity for short-term spending and goals within the next three to four years. The second pot is for long-term investments which you put into a portfolio and allow it to do its job of providing for the future. The third part is the satellite pot. You can use this if you want to take a flier on some stocks, invest in a friend’s business start-up or even invest in cryptocurrency.”
That satellite pot is money you can afford to lose and speculate with. Not everyone is in the happy position of being able to afford it, of course.
Equities
The need for investors to go into equities with their eyes wide open is echoed by Kevin Quinn. “Tina is the acronym that markets have attached to equities,” he notes. “There is no alternative.
“With cash and bonds offering such weak returns, well-diversified global equities are part of the solution for most investors – how much depends on your capacity for and attitude to risk. Equities aren’t cheap by most measures of value. They currently trade at around 19 times earnings, though these estimates have improved somewhat this year. That’s about 20 per cent more expensive than the average this century.
“What it means for the longer-term investor in equities is returns will be somewhat lower – my estimate is between 4-5 per cent for the decade ahead. However, there is a price to pay with equities – both in terms of volatility and indeed the risk of loss. Even the best diversified portfolios will go through downswings, so any investor new to this needs to build that into their thinking.”
Withstanding those downswings requires a plan, according to Kilmurray. “Everyone wants to time the dip in the markets, they want to buy when it’s 10 per cent down,” he points out.
“But the market has already grown by that much while you have been waiting for the dip to happen. There is only about a one in three or one in four chance that it will pay off. The problem with the dip is that everyone is waiting for it. They are right, the dip will eventually come, but you will have lost out on the growth before that. It is really important to have a plan and stick to it. Stop trying to second-guess the markets and have a plan.”
And one thing everyone agrees on is that having a good plan requires good advice.