Inflation is investment risk too

Last month, the ECB annoucned that they were cutting interest rates again to -0.5% in a bid to avoid a recession in Europe. It is expected that rates will stay negative for a number of years. This is more bad news for deposit holders who struggle to earn any return from their money.

A deposit holder might now expect to get 0.1% from a deposit account. For every €100,000 that they invest, they will get €100 back at the end of the year. And that is subject to DIRT at 33%, so they will only receive €67. Not great is it?

Inflation is always there

And to make matters worse, inflation for 2019 so far is running at 2.4%. That means that at the end of the year, the €100,067 will only buy you what was worth €97,665 at the start of the year.

Inflation is always around but rarely talked about even though we are aware of it when we notice price increases in the supermarket or when Netflix tell you they are going to increase prices again. Is is because we cannot physically see it reducing the value of your money?

Imagine you invested your €100,000 with me and after a year I told you it was worth €97,600 and the following year it was worth €95,258. If that went on year after year, you’d fire me.

Inflation is always there and World Banks typically want inflation to be running at 2%. It is a good sign that people are earning money and keeps manufacturing going. If we had deflation, people would spoke buying things, waiting for the prices to fall and buy it cheaper. This would result in job losses, recessions etc.

What is the solution for your money?

Unfortunately there is no magic solution. Deposit rates are non existent so if you want to make a higher return you have to take an element of investment risk with your money. That means that you have to accept that your money may go down in value as well as up. It may also mean that you have to hold your investment for longer than you intended if it has fallen in value.

How much investment risk you take is up to what level of returns you are looking for. You don’t have to put it all in the stock market or shares. You can also keep some money on deposit for use in the next few years while you let the markets do their thing.

If you are not happy with your money fluctuating in value, you will have to accept that interest rates are low and not producing any sort of return for your money and that’s fine.

If it seems too good to be true…

People who have accumulated large cash deposits tend to be very conservative investors and don’t like to take much risk with their money. They are nervous to dip their toe into the world of markets. So when they get offered an investment opportunity with a capital guarantee and the returns of equities, they jump at the opportunity. These are very complex products that lock away your money for the term of the investment, are difficult to understand and usually fail. Even the backtesting that some of them use to prove their great returns are easily picked apart.

There is no such thing as an investment which will give you above average returns without taking above average risk and that above average risk does not guarantee higher returns. You know that interest rates are -0.5% and the best you can get at a bank is 0.1%. So if you being offered the safety of deposits but with the returns of equities, run away fast.

If you have any questions, drop me an email to steven@bluewaterfp.ie