Today your editor is looking at the 7 November edition of the Australian Financial Review (AFR).
It still sits, (not quite) pride of place on our desk.
In big, bold black letters the headline screams, ‘Upgrade to shares, RBA tells savers’.
We wrote to you about that headline at the time. The Reserve Bank of Australia (RBA) wasn’t kidding. And we guess we can’t say they didn’t warn everyone about its intentions.
This week – as you doubtless already know – the RBA cut interest rates to 3%. That means the benchmark interest rate is back down to the so-called emergency low of 2009.
How come? Isn’t the Aussie central bank supposed to be so much cleverer than other central bank goons? Clearly not. When faced with a crisis the RBA has proven it’s no more capable than any other central bank.
And that spells bad news for Aussie savers…
But it’s not just the RBA kicking savers in the teeth by cutting rates. In yesterday’s AFR, columnist Philip Baker writes:
‘There’s a host of decent alternatives to term deposits that investors have flocked to in the wake of the global financial crisis.‘They include infrastructure, shares with attractive and sustainable dividends, property, real estate investment trusts, corporate and emerging market debt and even high-yield debt, or junk bonds. It all just depends on how courageous investors are.’
We almost spat out our afternoon cup of tea after reading that ‘junk bonds’ are an alternative to cash.
And as for ‘courageous’, we’ve always taken a different view on what ‘courageous’ means ever since Sir Humphrey Appleby’s definition on Yes, Prime Minister:
‘Controversial only means this’ll lose you votes, courageous means this’ll lose you the election.’
Mr Baker does concede that the assets he names are riskier than cash:
‘Shares and hybrids and any other investment all have risks attached. It’s about understanding the risk so if anything untoward happens, no one can say they weren’t warned.’
But even so, any suggestion that a term deposit is comparable with shares, property and junk bonds is ridiculous. If you invest in a term deposit, you do so because you’re after something safe.
Remember, this isn’t about asset allocation. This isn’t about putting 50% in cash, 25% in shares and 25% in gold. Based on Mr Baker’s reasoning, a saver should just take that 50% cash exposure and buy shares or junk bonds.
There isn’t a genuine investment advisor alive who will say a 50% cash exposure is the same as a 50% junk bond exposure.
Cash and junk bonds are at the opposite end of the risk spectrum. Dumping cash and buying junk bonds isn’t just a controversial move, it’s a ‘courageous’ move.
Artificially low interest rates will have a big impact on the latest investment vehicle of choice among the finance industry and central planners – annuities.
Here’s how the Australian newspaper reported a recent speech by former Prime Minister, Paul Keating:
‘He also hinted that he believed that there should be some requirement for people to put some of their superannuation savings into an annuity that would provide a stable source of income for their retirement.‘Mr Keating, who was the architect of Australia’s $1.4 trillion compulsory superannuation system, said the additional money raised by increasing compulsory guarantee from 12 to 15 per cent should be paid into a government “longevity insurance fund” which would be used to help fund the retirements of people over 80.’
An annuity may be a great idea if you bought one when interest rates were high, but what about today?
If the experience in the UK is anything to go by, the age of good annuity returns may already be over. As interest rates head lower and stay low, annuity rates are likely to fall.
As the UK Telegraph noted in September:
‘At the start of the Nineties, a £100,000 pension fund would have guaranteed an income of £15,640 a year for life. Twenty years on, a 65-year-old man will secure just £5,140 a year.’
Got that? Anyone who starts an annuity in the UK today gets only one-third the amount that an annuity investor got 20 years ago. Yet living expenses haven’t dropped two-thirds in that time.
And now Mr Keating wants to force Aussies to take out an annuity in retirement…even though it may be the worst possible time to buy such an investment. But that’s politicians and bureaucrats for you.
So, with interest rates going down, living costs going up, and investment risks increasing, what’s an investor to do?
We won’t claim it’s easy. All we can do is repeat a message we’ve spouted for more than a year. You’ve got to weigh up your own attitude to risk and then make your investment choices accordingly.
Above we mentioned that buying high-risk investments isn’t a genuine alternative to cash investments. If you’re not getting a big enough return on your term deposit, the solution isn’t to put all your money in a junk bond or property trusts.
In fact, arguably, given the increasing investment risks it’s more important than ever that you stick to your game and don’t let the mainstream and central bankers force you to take bigger risks than you should.
So, how can you do that?
The best way is to follow our ‘safe money’ and ‘punting money’ strategy.
First up, you need to figure out the kind of annual return you’re after. If you need a 6% annual return on your assets, you won’t get that from term deposits, but according to Mr Baker you can get around 4.2%.
That means you need to find a way of making up another 1.8%. So, should you ditch all your term deposits and buy shares that pay a 6% dividend yield?
No, because even dividend stocks are riskier than cash…certainly too risky to invest all your ‘safe money’.
So rather than taking a big risk by putting all your cash money into shares, look at the alternative.
Let’s say you have $100,000 and you want a 6% annual return ($6,000). Rather than take a big risk by investing all your money in shares, an alternative is to invest – say – $80,000 in a term deposit. That should give you a 4.2% return ($4,200). Then put $13,000 in share investments that yield 6%. That will earn you about $780 a year.
And then invest your final $7,000 in higher risk investments.
To reach your $6,000 annual income target you’ll need to make about 15% ($1,020) a year from the $7,000 high-risk investments.
We’ll be honest, that’s not easy in this market. But at least you’re isolating your risk. You’ve still got 80% of your money in a very ‘safe’ investment, 13% in a moderately safe investment, and only 7% of your assets in high-risk investments.
As we say, this isn’t fool-proof. It would be better if central bankers, politicians and bureaucrats didn’t make investing so hard by fiddling with interest rates and markets.
But that’s the world you live in and you need to make your best stab at achieving your desired returns without taking unnecessary risks.
So, where do you get that high-risk growth from? Our preference is small-cap stocks. Small-caps are the riskiest of the risky investments, but they can be the most profitable too.
You could use other methods too, such as trading stocks for short-term gains. That’s something favoured by our old pal Murray Dawes.
But we like small-caps because you know your maximum loss if things don’t go to plan (and remember, you’re only risking a small part of your portfolio), and you can make big returns if things do go to plan.
But whatever you decide, you’ve got to make sure you don’t chase higher yields without taking into account the potential higher risks. A 6% yield on a property trust isn’t the same risk as a 6% yield on the term deposit you took out two years ago.
Cheers,
Kris
From the Port Phillip Publishing Library
Special Report: The Big Money Secret of Ironstone Mountain
Daily Reckoning:
Why You Should Take Interest in the Current Account Deficit
Money Morning:
How Long Can the Market Ignore These ‘Warning Signs’?
Pursuit of Happiness:
What Can Stop Europe’s New Social Cleansing?
Australian Small-Cap Investigator:
Five Simple Steps to Picking Winning Small-Cap Stocks
