No one likes losing money. That’s what holds many people back from investing their money in the stock market, the fear of a dip in value. It also drives them to the supposed safe haven of short-term deposit accounts which offer interest rates of between zero and 1 per cent – significantly below the rate of inflation.
But while the cash on deposit is safe, its value is actually falling due to the silent thief known as inflation. The question facing people in the happy position to have spare cash to save or invest is how to beat inflation without taking on too much risk.
“It’s fine to be conservative,” says Eoghan O’Hara, country head Ireland with Raisin Bank. “I don’t think any financial planner or adviser worth their salt would try to convince a conservative investor or saver to go against their better judgment or gut feeling and lose sleep over an investment.”
However, he says people should be aware of the risks they run while being conservative. “Let’s just take 2 per cent as the running figure for inflation. You’ve got €10,000 in the bank and you’re logging into your banking app and at the end of year one, it’s still €10,000 and it’s the same at the end of year three. Well, that’s great. Your €10,000 is still there. But if everything around you like household bills, groceries, childcare, insurance and so on is getting more expensive, well, that €10,000 isn’t worth what it was.”
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Gary Connolly, head of investment advisory and execution only at Davy, believes this impulse to protect what we have is instinctive to us all. “Aversion to risk is innate, passed down from our hunter-gatherer forebears,” he says. “We are predisposed to overweight the negative. Even when presented with a favourable proposition, we will generally avoid it if there is the potential for significant downside.”
But what if the risk you are managing is not the correct one? he asks. “For most people, the risk we are averse to is capital loss – usually short term – and the variability in the value of our principal,” he explains. “But that’s not the appropriate measure of risk to a long-term investor.”
He notes the Warren Buffett description of investing as “forgoing consumption now in order to have the ability to consume more at a later date”. “The measure of risk implicit in this definition is inflation,” he says. “If you are an investor, this is your appropriate measure of risk. If you accept this proposition, this likely upends what your gut tells you constitutes low and high risk.”
His thesis is that we are concerned about the risks of doing something – making an investment decision – but not concerned about the risks of what we would perceive as doing nothing – defaulting to leaving money in cash which is earning a negative real return in many cases.
“We need to consider the possibility that risk is more than just short-term capital loss and volatility,” he adds. “We should all be averse to losing our capital – but we should measure that in real after-inflation terms, not in nominal terms as most people tend to do.”
O’Hara points out that people don’t necessarily have to get into risky investments if they want to beat inflation. “I wouldn’t completely write off deposit accounts, but most people are leaving their money in the wrong ones,” he says. “If you look at the latest Central Bank figures, there’s roughly €170 billion of household savings on deposit in Ireland and 90 per cent of that is sitting in accounts earning less than 1 per cent and in most cases close to zero per cent.”
[ Over-saving may be quietly costing Irish households thousandsOpens in new window ]
What’s the alternative? O’Hara explains that there are two types of deposit products – overnight accounts or demand deposits, and fixed-term deposits. “If people feel that they’re willing to lock their money away for a set amount of time, whether that be one year, two years, three years or even six months, they can oftentimes get better rates because the bank is getting the reassurance of having access to that capital for the agreed term. But even for the shorter fixed terms or the overnight deposits, there’s plenty of options out there. It’s quite simple these days. We’ve all got access to smartphones and computers, and we can shop around and compare different providers. But people should definitely do their homework on what they’re signing up for.”
Of course, the equity markets have, over the long term, delivered far superior returns to bank deposits. But Irish people tend to be more conservative than their European counterparts when it comes to investing. “Maybe it’s a lack of awareness, a lack of knowledge of the different products and their implications,” says O’Hara. “We’re certainly behind the eight ball in terms of putting our money to work. With savings it’s about having that security that your money’s there when you need it. Even having said that, isn’t it better to earn a few bob off that money as opposed to leaving it in a zero per cent account?”
O’Hara advises people to take time out to consider their financial situation on a regular basis. “It’s not something that I’d encourage people to be thinking about every single day of their lives, but if you actively look at your financial situation once every six months for 30 minutes, you’d be surprised how enlightened you can be. You might say, ‘Hang on a second, I’ve had money in this account earning nothing for years and if I make a switch, I can start at least earning something for my money’.”
