Low rates environment – What to do?
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When we speak to investors who have spent years building up their capital and nest egg, so they can rely on it to fund their advanced years, they tell us their significant concern right now is how to allocate capital in a low rates environment. When interest rates are at an all-time low it isn’t easy to get a cash return from your portfolio, it is worse if your risk dials are set to be very conservative. This situation is unlikely to change anytime soon.
So what is a conservative investor to do right now? - Let’s review what are broadly the different investment options available to investors. As we see it, investors can broadly invest in four main asset classes, Cash, Fixed Interest (e.g. bonds, credit, hybrids), Property, and Shares. Each of these categories has its nuanced risk and return profile. Further, whilst we haven’t considered Alternatives here, we will in a follow up note. Generally speaking, cash is least risky with a low return (read no return) to match. It is key that investors understand what risk means and how it relates to the required returns or to state more generally to meet their financial goals.
Cash
“Cash is always a bad investment. Anytime we have surplus cash around I’m unhappy I mean I would much rather have good businesses than cash. I’d much rather own a good business than have cash and it is a hedge against the dollar ... well you can say all assets are a hedge against a dollar, I mean, but that all you know is that the dollar is going to be worth less 10, 20, 30 years from now.”
The general rule of thumb is that cash in your portfolio will earn you the least amount of return because frankly it is not being put out to any direct use by you (indirectly yes). The issue with cash is that positive inflation will erode the value of the cash you hold in a low paying account, worse if you are drawing down to fund your lifestyle. This means you can be left with nothing but a dwindling pot of cash over the course of time.
Bonds
The next in line of higher risk are bonds. These range from pure debt, from governments or corporates, to credit with hybrid structures that have both debt and equity characteristics and are higher risk. You can buy bonds on the market directly or invest through a fund manager. In a low returns environment investors may consider going direct (if you are well advised) rather than going through a bond manager and adding a layer of fees to your already lowly expected returns. However, we would exercise caution given these securities can often have complex structures, maturity dates, reinvestment and credit risk.
Property & Shares
In order to see any sort of decent returns on your money in an era of ultra-low interest rate on cash you really have two options if you are financially dependent on your savings to fund your advancing years. Number one, keep in cash and drawdown your principle savings or number two consider moving higher on the risk spectrum this year. By most accounts we are likely to remain in a low interest rate environment for some-time to come. Investing in either property or shares of high quality companies that generate better total and cash returns (through regular and special dividends and buybacks) could be a better alternative.
