Investing has always been about obtaining a reward relative to the level of risk you are happy to accept. The reward has been the return you received above inflation. This is referred to as the real return. The higher the reward, the higher the risk.
Previously there has been a “Reward for Safety” as cash rates were above inflation rates. For example when you could receive 5% on a Term Deposit, with no risk and the inflation rate was approximately 3%, you received real return of 2% while your investment was protected from negative returns.
The conundrum today is that there is no “Reward for Safety” – the inflation rate is currently approximately equal to available cash rates if not higher. By seeking short term security and leaving your investments in cash your investments are losing purchasing power. Even worse leaving investments in cash and living off the balance will see accelerated capital erosion.
Over the last 40 years the average investment return in Australia from Growth Investments such as Shares or Property has been approximately 5% above cash rates. Of course investments in these areas are not protected from negative returns.
Not seeing a negative return can provide an investor with a feeling of security. Under current economic conditions if not receiving a negative return is due to an exposure to cash that is earning less than inflation the feeling of short term security could lead to longer term pain and loss of financial choice.
Allocating investments within your risk tolerance for both short term use and long term gain, whatever the current economic conditions are a conversation we should have when we are reviewing your financial planning objectives.
Based on long term data protected cash investments will currently return approximately 2% per year (with a guarantee) while growth investments will return approximately 7% per year (on average with no guarantee). If you don’t need to use growth investments in the short term the likelihood of these investments providing there long term average returns is increased.
Your reward for risk from a growth investment from this scenario is 5% per year.
Important Information: The information in this article is of a general nature only. Before you make an investment decision you should assess for yourself or obtain professional advice on whether the information is appropriate for your particular investment objectives, financial situation and particular needs.