Over the last few years, cash has very much been the choice for Irish investors as other assets have been largely avoided. This risk aversion has been driven by investors’ experience during the financial crisis of 2008 and the destruction of wealth in its aftermath.
The ‘flight to cash’ was aided by the artificially high deposit rates on offer from the Irish banks just as the focus of investors shifted from capital growth to capital preservation. If an investor could get a ‘guaranteed’ rate of return of 5% or more from a deposit, they opted for this and effectively postponed an investment decision.
Another refuge for the risk averse, both here and abroad, has been fixed interest funds. J P Morgan says that approximately US$2 trillion has gone into fixed interest funds over the last four years compared to US$400 million invested in equity funds.
Investors who poured money into bonds and deposits may soon be grappling with inflation and if interest rates rise, the value of their fixed interest holdings falling. While the possibility of interest rates rising in the current global environment may seem unlikely with rates at historic lows, the reality is that in many regions there is only one direction for them to go – upwards.
According to the Central Statistics Office, the Irish inflation rate has averaged 5.3% from 1976 to 2012, so it does not take much calculating to figure out the negative returns investors could make if inflation reverts to average levels. Inflation is a serious threat to investors with fixed rate investments, as there is no way to recapture lost purchasing power.
The most important thing an investor should do is to draw up a plan with a trusted financial adviser using realistic assumptions to achieve investment goals over the desired time horizon. Once a plan is decided upon, it is important to stay disciplined regardless of the short-term noise that markets or the media makes. Make sure that you have allocated your investment across all major asset classes in a balanced portfolio.