06 Nov The double I Risk
While there are plenty of people rejoicing over lower interest rates at the moment, the conservative investor is quietly mumbling under their breath.
Conservative investors who’ve long stuck to term deposits and high interest saving accounts have been hit with the double whammy of interest rate risk and inflation risk.
They may have been able to snag a term deposit above 8% for a brief period in 2007 and above 6% between 2009 and 2011, but those days are long gone.
Right now 4% looks generous from an online bank and sub 4% is the reality from the big four.
Anyone rolling over a term deposit from those days is taking a large income haircut, yet at the same time they’ve also received no capital growth.
Even if their interest rate had remained the same, the income their investment generates would still have been impacted by inflation.
Assuming an inflation rate of 2.5%, an investment producing $1,000 of income today needs to be producing $1,131 of income in five years to maintain an equivalent level of purchasing power.
And therein lies interest rate risk and inflation risk.
It’s somewhat of benign risk combination because it doesn’t look like you’ve actually lost anything.
Which is true if you just leave your money in the bank and occasionally look at the balance to see it’s still there.
However, if you’re spending the income you’ll certainly notice you’ve lost it because sooner or later what bought you a block of Cadbury chocolate will only buy you a bar of Cadbury chocolate.
My concern is always the same in lower interest rate environments – what risks will normally risk averse investors feel compelled to take in the attempt to make up a shortfall?
It’s the area spruikers and conmen will usually invade to peddle supposedly risk free, yet higher return investments to prey on the desperate and naïve.
There’s no risk free, high return investment, so consequently, many will be duped – don’t be one of them.