The investor is losing moneyPosted on: 20 April 2009 by Gareth Hargreaves
Independent financial advisor Peter McGahan explains why investors are actually losing money and the effect quantitative easing may have on improving the situation.
With such dismal returns being available on cash do you believe there are better solutions for investors who want to make a better return and what risk will they have to take?
Admittedly the returns on cash are very poor at the moment and with the retail price index (inflation) at a higher level than cash returns, the investor is actually losing money.
Will the returns on cash remain low? Well, much actually depends on how quantitative easing works and how quickly. If it bites quickly that will be good news and we may well see interest rates begin to rise again to slow consumer demand. If it is slow to kick in and more quantitative easing is employed, there will be the danger that when the quantitative easing measures bite, they could run away with themselves before the position could be reversed. This can easily cause high inflation if not managed correctly.
If this happened you could see interest rates soar in an attempt to curb excess inflation. Will this happen soon?
I am already seeing an impact on the consumer because of low interest rates. Many first time buyers are returning to the market with deflated house prices, low borrowing rates and government incentives all making home ownership a more attractive option than excessive rents.
I am also seeing consumers doing what I expected would happen, and that is too rid themselves of excess debt. I suspect by late summer many of these consumers will be much more content with their financial position with reduced debt, and now much lower payments to contend with because of that reduced debt coupled with lower interest rates.
Quantitative easing should have supported banks’ coffers by then but I am confident that banks will still need to see a more supportive economic environment before they relax their purse strings. The above will support that.
And so my view of a turn in the markets within the next year is supported by these thoughts and the potential for better returns coming from cash as interest rates rise to slow growth to manageable levels.
In the meantime for the cash investor all that is offered to you for the same level of risk is a one to two year deposit where you don’t have access to the cash. I would simply take out what income you need for the next one to two years and lock the rest away for the relevant period to obtain the best returns.
If you are happy to take risk with your investment however, corporate bonds are an alternative. Yields will be falling because of quantitative easing but the valuations of bonds have been under pressure for some time.
Let me explain why: bonds are a loan from you to a company or a government. They offer you an income (coupon) for a set period of time, then a return of your capital.
The risk is that they default on either of these. At the moment, default rates on bonds are being priced into bond prices at an all time high. If defaults on these are not as Armageddon like, investors could see a sharp rise in the underlying price of the bonds they are invested into.
For the more forward thinking and brave cash investor they may well consider the price of the stock market at present. Returns have been dreadful and markets have really priced in much of the bad news.
I am confident there will still be some further bad news before the bounce, but in five years from now I am also confident that any equity investor will be pleased with their returns.
In the meantime those investors wanting to take advantage of this who are sitting with cash ISA's should be aware that they are permitted under the new rules to transfer from cash ISA's into an equity ISA, but not the other way round.
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