"You earn nothing" but can you afford to do nothing?
In recent discussions with our investment team they have regularly and emphatically made the point, “you get paid nothing for taking on no risk”.
This is illustrated in the chart below where the green line signifies where risk and return are positioned today (compared to the past, illustrated by the red line).
Where six years ago you could achieve a return of around 3.2% by taking zero risk,
today the return is close to 0%
And a couple of weeks ago we had the following announcement from Denmark.
Denmark's pension industry, twice the size of its economy and ranked the best in the world alongside that of the Netherlands, is now taking another step into uncharted territory.
The Danish regulator has decided it's no longer feasible for funds to promise savers in guaranteed-return products that they'll get at least 1%. So from July 1, funds will only be allowed to guarantee savers minus 0.5%. (Savers opting for riskier pension plans that track market rates aren't affected by the change.)
A negative return guarantee "is a weird concept," said Per Ploughmand Baertelsen, Assistant Director General at the FSA in Copenhagen. But that's what savers need to accept, if they want to place their money into products "with zero risk, or low risk."
A weird concept indeed! They will only guarantee a return of minus 0.5%.
Now, compare this to when I started in the financial services industry in 1988, and the trustee arm of a major insurance company that employed me offered an “at call” account providing 13% p.a. to investors! Or in the late 1990s when you could purchase (from an insurer) a lifetime annuity returning around 7% to 7.5% p.a.
The risk of taking no risk
While our investment team navigate the implications of this “zero return for no risk” environment on developing investment portfolios, investors are also left in a quandary. If I want a return of x% how much risk must I take to meet my objective? Or put another way, how do you develop your own wealth strategy to take this environment into account?
This was major topic of recent discussion with clients holding a large amount of cash who were concerned about markets and volatility.
Simply, they had three options:
- They could leave the funds in cash earning around 0.5%p.a. and lose (before tax) about 1.5% each year in purchasing power (assuming a 2% p.a. inflation rate). This equates to a 5% reduction in purchasing power in three years; or
- Consider a “cash plus” option that at least tries to retain purchasing power over the next two to three years (targeting around 2.5% to 4%); or
- Use a diversified portfolio of assets with a three to five year time frame that aims for a return of around 4% to 5% p.a.
They ended up choosing a mixture of options 2 and 3.
For many clients, their capital needs to at least maintain purchasing power (and, better yet, grow in real terms). There are few investors who can truly “exist” on zero return or see their purchasing power reduced.
What can you do?
So, while our investment team develops portfolios acutely aware of the nature of future investment returns, we each need a set of practical solutions to ensure we are well placed for the next 10 years and beyond.
When you next speak to your Strategist, you could ask them the following questions as a starting point:
- How much volatility can I manage in order to get a real (i.e. after inflation) return?
- Do I know what my capital spending plans are for the next two years?
- Are my investment assets held in the most tax effective structures?
- Is my portfolio specifically tailored to my needs?
- Am I prepared (or able) to adjust my spending in volatile periods?
- Does investment debt make sense for me?
Your Strategist has a number of approaches that they can use depending on your overall circumstances.
Good financial advice from an expert you trust is an invaluable tool in managing risk and protecting your peace of mind.