Interest rates on short to medium-term German and Japanese government bonds are effectively negative, implying an investor is guaranteed to get back less money over the life of these bonds than what they invest in the first place.
Paying for the dubious privileges of lending to the Japanese Government, when its debt sits at over 240 per cent of GDP, beggars belief. People and organisations relying on the income from cash and government bonds have had to make tough choices in the advanced economies.
Either spend less, or somehow increase the amount of assets invested.
In this environment it is no surprise that many investors have pursued a third option - changing the form of their investments held towards assets with higher income yields.
New Zealand has not been immune from the low interest rate environment, and recent cuts of the RBNZ cash rate to a record low of 2.25 per cent have intensified this challenge.
Economists and market pricing suggests interest rates will not materially rise over the next few years.
Unfortunately, the risk that interest rates will grind lower towards the near zero levels in advanced economies cannot be discounted.
In short, bank deposits rates are likely to remain extremely low for the next several years, and like savers and investors in the advanced economies, expectations need to adjust.
This will likely prompt people to consider re-allocating savings towards higher yielding assets.
Moving from (almost) risk-free short-term bank deposits towards higher-yielding assets inevitably involves taking on more risk.
This will include risk that the market price of the assets could fall (yes, this holds even for residential property), and could include risk that the income flow from the assets are less than expected (eg, because a landlord gets a bad tenant, or because a company cuts its dividend), risk that the investor will not be able to withdraw funds or sell assets when needed, and risk that the counter-party that the funds are invested with fails.
These risks can be well-managed by ensuring an appropriate level of asset diversification, ensuring the asset allocation is aligned with risk tolerances, and ensuring investments are made with a reputable counter-party.
Full transparency on fees, including any performance fees and brokerage, and appropriate accounting for tax, is also crucial as it is the post fee and tax return that matters.
We can expect to see many suitors arise for the affections of savers who have relied upon term deposits.
This affection should only be given when the risk, fee and tax implications of the investment are thoroughly understood.
- Aaron Drew is chief investment officer with Hawke's Bay wealth-management company Stewart Financial Group.
