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Investment & Retirement Income Planner
27th July 2020
This week we share an investing concept that applies to investments and pensions equally. If I successfully and coherently share here what is in my head, it will hopefully help remove stress for investors as they begin, continue or end their investment journey.
A Simple Concept
Simple concepts are often the most memorable and usable. Here’s one such example. It was 2010, I had taken to cycling with a local cycling club here in the North East, Drogheda Wheelers. As a novice, I began cycling with the ‘leisure group’. This was made up mostly of experienced and more ‘mature’ cyclists who had given up the racing and were content to cycle with friends on a Sunday. One such experienced cyclist imparted a valuable piece of information to me. Recognising that my bicycle was a ‘gate’ (basically, not good!) he suggested I be aware of a fact of life with regards purchasing a new bike.
There are three main variables with regards bicycles; cheap, light, durable. The key aspect however is that, you can only ever get two of the three at any time! And was he spot-on. If you buy something that is light and durable, it won’t be cheap. If you pick something that is cheap and light, it won’t be durable, and so on. A simple, and effective way to know your Sora from you Dura-Ace! The same type of simple principle can be applied to many aspects of life – investing being no exception!
First things first. We’ve always encouraged investors to focus on the ‘real returns’ when they decide to invest. The ‘in your pocket’ return really is the only barometer of success we should consider. In pensions this is somewhat easier, as they will grow without tax payable on the growth – unlike investment accounts, or most any other form of capital gain from investing.
According to Investopedia, inverse correlation is defined as: “An inverse correlation, also known as negative correlation, is a contrary relationship between two variables such that they move in opposite directions“.
Certainty or Return – Pick One!
Certainty and returns when investing are inversely correlated. They have always been, and there is zero sign that that will ever be otherwise. It is a simple concept, just as the one from my cycling friend was. In addition, it should help remove an awful lot of stress for you as an investor.
Example of High Certainty and therefore Low Returns
Deposit accounts deliver high levels of certainty in the rate of growth you will receive. Usually this is in the form of a set rate of return over a set period on a set amount of money you invest. While the institution you deposit the funds with can go off and make very productive use of your cash, they offer you a certain level of return for you leaving it with them to do so.
According to a Central Bank of Ireland publication (read it here); interest rates on domestic deposit accounts stood at 0.02% Gross. Yes, one-fiftieth of one percent. The likes of a 4-Year National Solidarity Bond, can be a very decent home for short term accessible cash and typically offer better rates than the banks and it is DIRT free. They will offer you around half of one percent per year.
Of course interest rates on deposit have not always been so poor. Back in 2011 I was working as an advisor in a bank branch, and there were rates of 4% Gross per annum from memory. Even then, in terms of Real Returns after inflation and DIRT tax you were achieving 1% max.
The Real Returns of deposit accounts are typically within 1% either side of zero. The only certainty currently is a loss of purchasing power of your money.
Another High Certainty investment is the likes of Tracker Bonds, also known as Kick-Out Bonds or Protected Bonds. These offer the allure of equity growth but with none of the risk – which is a stretch of even the most dull imagination! One such product was being touted to someone who got in touch with us for independent investment advice. When we looked under the hood for them, the product had set-up costs of 8%, of the clients investment – with little or no chance of delivering anything much more than the State Savings offering above. Not great for the investor, whatever about the sales-person flogging them!
Historical deposit account rates here are hard to come by. Bond Fund historical performance, which have delivered similar levels of return for investors is ample. At a volatility rating of 2 to 3, a Global Bond Index has delivered average annual long term Real Returns of 1% approx. Whichever way you slice it, while great for providing access to cash they are a High Certainty – Low Returns option, and have always been.
Low Certainty – High Returns?
There are umpteen options we could choose from here – but for now I’ll focus on that classiest of asset classes, equity! The long term returns of smart diversified equity investing is over 10%. In ‘real returns’ basis, after fees, inflation and tax on growth, you have achieved 4 to 6 times that of the above ‘certainty’ route.
Taking an example of a Vanguard Index Fund which tracks the MSCI Index. Such a fund tracks a basket of 1,600 large globally diversified companies. There is a high degree of uncertainty when investing in such an option. What I mean by that, as we saw in Blog 148, we do not know what the value of that investment will be in 6 months, or even 6 years.
Investors who accepted low certainty have also been rewarded with high returns. Had you invested €100k in 1998 you would have seen it grow to €170k within two years. It then had a major temporary decline due to 9-11, falling to around €80k. It then recovered to €150k before the Global FInancial Meltdown hit it in 2007, falling temporarily to €80,000 by mid 2009. On it went then on a upward curve to €320k in Feb 2020. Of course, Covid 19 then happened, at it temporarily declined to €250k. It then recovered quickly and now sits at €305k. Lot’s of uncertainty – we thought the world was coming to an end three times in the course of those 20 short years.
The Bottom Line
As another aside, have you ever reflected on how it feels when you attempt something that you are not certain you can achieve? Something realistic but very stretching for you? It might have been a physical challenge, an academic endeavour, a relationship obstacle or a professional milestone? How goes does it feel when you complete the task? In taking it on we know that it won’t always work out immediately. We know we will have to review the game-plan and try again. We know that if we keep trying and keep improving we will eventually succeed. This is a low certainty and high growth option to take.
It is the uncertainty of it that brings out the best in us. If we remain static, in the Status Quo, where there is high certainty, we typically regress. Only by taking on an appropriate level of uncertainty do we grow. The very same can be said of one’s investments.
We do also know that it is very difficult to make a good investor out of a natural pessimist. Life-time success is build on an informed respect for economic and market history. It is therefore built on evidence based optimism.
Not only do we accept the uncertainty, we welcome it – for we know that it is that very factor that enables us to achieve our long term goals. I am so grateful to work with people who recognise and live by that very simple (but not at all easy to apply) fact. Of course there will be uncertainty ahead, and I reckon our resolve will be tested to the limits at times. But when the ‘real returns’ are not numbers but individuals living the a dignified life with little or no concerns about their investments, that’s a ‘return’ worth going for.
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