AUG 13 2019
All Posts
AUG 13 2019
All Posts

When bank deposits just aren't enough

Posted by: Henry Ford, Rutherford Rede in opinion

Interest rates are low and look set to stay that way for a while.

In Germany and Japan if you invest in a ten-year government bond, not only will they pay you nothing, in ten years you get repaid less that what you put in. This is something we have not experienced before and no one really knows how it will play out. 

The problem is for those who depend on deposit interest to live, this is tough. When deposit rates settle and when the reality sets in then what this means on a day-to-day basis will become clearer.  What is obvious is that for depositors this is not good news. 

While this is different, we have been somewhere like this before.

Back in the early part of the 2000’s interest rates were falling from previous highs. Those who depended on deposit income found they had less and they looked to plug the gap. After the 1987 crash, the idea of taking risk didn’t appeal. In response to this, assets that looked a lot like term deposits became available and they were paying higher rates. As we know only too clearly now, finance company debentures filled this very fertile ground and very few understood what it was they were investing in. Investors in these didn’t want to take a risk so invested in something that looked like a term deposit. It turned out those term deposit instruments were a lot riskier than things like shares but offered a very small premium, and as it emerged there was a high chance of a complete loss. 

Why would we refer to this now? 

It is against the prospect of low interest rates that investment opportunities that look low risk for a higher return could start to reappear. It has not happened yet but these interest rates look set to stay so there is plenty of time. Risk and return are always related. A high risk demands a high return. 

Rational people will not take a risk unless they expect to be compensated for it.

By the way risk is something that is talked about but not always understood. What is risk? Risk is uncertainty about a future event, and the outcomes of that event could be adverse. It is possible to get high returns, but it must involve taking risk. The key is not if you take risk. It is how well is that risk understood and how well is it managed. If this is something you are pondering here are a few principles to guide you: 

1. Understand what it is you are investing in. If you cannot, then don’t invest. 

2. Diversify. This means three things: 

a.  Spread your investments around assets that work well together.

b.  When investing in things like shares, bonds and property invest in lots of them. If one fails you have all of the rest. You miss the stars but also the failures. What you get is the market average and in the long term that will be just fine.

c.    Spread your investments around the world. Different markets peak at different times. 

3. If your investments are likely to go up and down then invest for the long term and stay in. Markets spend a long time doing virtually nothing, but can also do a lot in a very short time. Don’t try to anticipate market movements, you will almost certainly be too late. 

4. Know what you can afford to spend without running out of money. Then stick to it, and have a system that tells you how you are going.

Can you eat into capital? 

Spending capital has historically been regarded as a last resort by investors. That is true if you are in a wealth building phase, but remember you saved while working so that you could spend it later. If you don’t spend capital then at the end of your life all this money will still be there. And what happens to it then? It’s not easy to take it with you. The key is to determine how much you want to finish life with and develop a spending plan to use your money but not to run out. When interest rates are low then planning is more important than ever. Low interest rates may mean looking beyond the bank. If you do, then understand what you are looking for, and be sure that the solution you find is right for you. 

Yes, things have got harder, but equally we know how to be smarter.

Tags: interest rates, investing, diversification,

Interest rates are low and look set to stay that way for a while.

In Germany and Japan if you invest in a ten-year government bond, not only will they pay you nothing, in ten years you get repaid less that what you put in. This is something we have not experienced before and no one really knows how it will play out. 

The problem is for those who depend on deposit interest to live, this is tough. When deposit rates settle and when the reality sets in then what this means on a day-to-day basis will become clearer.  What is obvious is that for depositors this is not good news. 

While this is different, we have been somewhere like this before.

Back in the early part of the 2000’s interest rates were falling from previous highs. Those who depended on deposit income found they had less and they looked to plug the gap. After the 1987 crash, the idea of taking risk didn’t appeal. In response to this, assets that looked a lot like term deposits became available and they were paying higher rates. As we know only too clearly now, finance company debentures filled this very fertile ground and very few understood what it was they were investing in. Investors in these didn’t want to take a risk so invested in something that looked like a term deposit. It turned out those term deposit instruments were a lot riskier than things like shares but offered a very small premium, and as it emerged there was a high chance of a complete loss. 

Why would we refer to this now? 

It is against the prospect of low interest rates that investment opportunities that look low risk for a higher return could start to reappear. It has not happened yet but these interest rates look set to stay so there is plenty of time. Risk and return are always related. A high risk demands a high return. 

Rational people will not take a risk unless they expect to be compensated for it.

By the way risk is something that is talked about but not always understood. What is risk? Risk is uncertainty about a future event, and the outcomes of that event could be adverse. It is possible to get high returns, but it must involve taking risk. The key is not if you take risk. It is how well is that risk understood and how well is it managed. If this is something you are pondering here are a few principles to guide you: 

1. Understand what it is you are investing in. If you cannot, then don’t invest. 

2. Diversify. This means three things: 

a.  Spread your investments around assets that work well together.

b.  When investing in things like shares, bonds and property invest in lots of them. If one fails you have all of the rest. You miss the stars but also the failures. What you get is the market average and in the long term that will be just fine.

c.    Spread your investments around the world. Different markets peak at different times. 

3. If your investments are likely to go up and down then invest for the long term and stay in. Markets spend a long time doing virtually nothing, but can also do a lot in a very short time. Don’t try to anticipate market movements, you will almost certainly be too late. 

4. Know what you can afford to spend without running out of money. Then stick to it, and have a system that tells you how you are going.

Can you eat into capital? 

Spending capital has historically been regarded as a last resort by investors. That is true if you are in a wealth building phase, but remember you saved while working so that you could spend it later. If you don’t spend capital then at the end of your life all this money will still be there. And what happens to it then? It’s not easy to take it with you. The key is to determine how much you want to finish life with and develop a spending plan to use your money but not to run out. When interest rates are low then planning is more important than ever. Low interest rates may mean looking beyond the bank. If you do, then understand what you are looking for, and be sure that the solution you find is right for you. 

Yes, things have got harder, but equally we know how to be smarter.

Tags: interest rates, investing, diversification,

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