How to survive strange times in the markets
With some banks and governments charging you for the privilege of taking your cash, does your money really have no value? Of course it does, says Bengt Saelensminde. You just have to think outside the box.
Savings rates are appalling right now. I mean, what can you get? 2%, maybe 3% max?
And it's even worse if you have serious cash on the hip. If you want to tuck away a six figure sum you probably won't get anything at all if you want instant access.. In fact, in many cases you have to pay a bank to keep your money safe!
It's the same with government bonds. Stick a chunk of your money in the best looking government debt and you're looking at negative real' returns for the privilege!
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This turns modern finance on its head. The concept of time value of money' is lost on investors today. There seems to be no value to money!
And that's exactly what the guys in charge want you to think. They want you to believe there's no value to your cash.
But that doesn't make sense. Today I want to seriously consider why the time value of money has turned negative. And I want to show you how to make the most of this strange new world
Why low returns are here to stay
The return (or interest) you get on your money tells us how much that money is valued. So with rates so low, are we really saying there's no value to your money? Of course not. In fact, if you take a close look you'll see that there are plenty of people out there desperate for your money.
Small business owners are forever kicking up a stink about the fact that nobody's willing to lend to them. And the papers are always brimming with stories about families desperate to borrow just to make ends meet.
These are strange days indeed. Those with cash don't want to let go of it and will pay good money just for the security of getting it back. While those without it can't get it not for love nor money!
And I can't see that changing.
Towards the end of 2008 interest rates started falling as the economy crashed. In March 2009 the base rate bottomed at 0.5% and hasn't budged since. That's around three years of negligible returns for cash-savers.
And for all I know we could well be looking at another three years to come, especially when you consider the inflation outlook. Inflation never really seemed to bother the Bank of England's Monetary Policy Commitee (MPC) anyway. But now that it's starting to fall we certainly shouldn't expect a rate rise anytime soon.
Think about it. Our main trading partner is Europe. And the pound has strengthened against the euro which means that many of our imported goods should be cheaper down the line.
At the same time, falling commodity prices and the fact that the VAT hike is working its way out of the inflation figures will also help.
But most of all, a weak economy will help keep prices down. I mean, even the mighty Tesco is suffering!
The point is that if we weren't treated to higher interest rates while inflation was moving up, then we're hardly going to get them when it's on the way down.
Why negative yields make sense
The financial world tells us there's no value to our money and that message is likely to persist.
But in the real world, it's patently not the case. And to make sense of this conundrum we need to look at things from a different angle.
A negative return on cash seems odd... but when you compare it to a potentially larger negative return from stocks, then you can see the sense. That's why investors are paying money just for the security that they'll get their cash back. If they put it in the markets, there's a very big risk that ultimately they'll end up with a capital loss.
Just consider the pension funds and insurers out there that simply can't risk taking big losses in the markets. They're forced into negative yield investments and it's not as stupid as it sounds.
How I'm splitting my assets in a low interest world
Back in June last year, I poked fun at the head of Schroder's European fund who was quoted in the Sunday paper: "The Greek-focused panic in the markets is creating some fantastic investment opportunities..." He was telling us how he was filling up on European banks!
I wonder if he's still got a job!? Most of the continental banks have fallen off a cliff since his wise words were published.
And this is what concerns me. It's not that stocks don't look cheap relative to cash. They do...
My problem is that they could look a lot cheaper down the line. What good is a nice dividend if you end up with a bigger capital loss?
Given that many shrewd investors in the City are paying good money just to ensure they get their cash back, then maybe we should consider ourselves lucky to be getting a relatively handsome 3% cash in a tax efficient ISA. What's more, we get a free government-backed guarantee up to a value of £85k.
I'm not 100% cash though that would hardly follow my thinking about the importance of diversification.
In case you missed my mini-series on asset allocation, I'm still holding 25% cash, 25% bonds, 25% defensive stocks and 25% commodities.
Negative returns on cash signal strange times in the financial markets. And to survive we need to think a little bit outside the box. Keep reading The Right Side for more ideas of where to put your money in 2012. There should be some great opportunities ahead to pick up quality assets cheap. I'm on the look-out.
This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.