Wednesday, September 30, 2009

Why are investors still sitting in cash- relevant to interest rate trends?

During this period I've been holding more GIC's than usual, as I waited out a market collapse and restructuring.

During this same period, a great deal of investors, who suffered horrible losses due to poor investment strategy, exposure to margin calls and other various gambles; have been shifting money out of losing asset classes (usually in the form of mutual funds or etfs) and waiting in cash for a different approach.

This has been the typical scenario I have faced along with most if not all of the retail investors in Canada. Before the credit crisis and ensuing collapse of worldwide economies, GICs were always capable of generating some amount of short term interest. In the early 1980s, guaranteed deposits with banks could issue interest over 7-10% for a 1 year investment. Why would you ever just sit in cash, no matter how liquid the form, when you could earn 10% simply by not touching it? People have all different reasons for investing, but the logic is simple.

During the worldwide meltdown of the past year, central banks lowered the rates at which they lend money to approximately 0.25%, this has had the consequence of reducing the interest on the typical savings account or 1 year GIC to the lowest point in history. These products still offer an interest rate in the range of 0.5-0.7% and you can typically negotiate a price with a financial services representative. The important fact remains, once the fees for these products (and there are always fees, hidden or not) are deducted from the annual yield, you are left with a return of approximately 0%. You are being paid absolutely nothing to simply wish to preserve your cash.

The mainstream media is reporting that a great deal of investors are sitting in cash because those who have switched out of one investment or asset class always place the money in cash. Investment advisors and DIY investors rarely ever have any idea when and where to invest money. "Rules" of investing, typically apply only when you are reinvesting into a product, usually an interest payment, mutual fund or DRIP with common equity in which you reinvest whatever growth occurs in dividends or your savings at regular intervals. There is a much larger problem when you are forced to have your principal returned (like with a bond), you suffer such terrible losses or you are forced to liquidate your holdings (like with funds and stocks that offer poor long term returns and margin calls).

So here is the relevant fact to consider if you are being told you have missed a rally and are tempted to throw large wads of cash at the stock market: when economies experience deflation, which is what investors are witnessing at this time, interest rates are so low that a 0% return on a portion of a portfolio of investments is still technically a positive return. The logic is simple, if the purchasing power of your money does not decrease over a one-year or two-year period, you will not lose any money and have not missed any opportunities to make greater earnings in the future.

Investors chase poor investments because they feel pressure to earn returns on their investments that are equal or superior to the market, underperformance equates to the destruction of your wealth from this perspective. However, intelligent and informed fixed-income investors never fret over missed opportunities in market rallies. The nature of a laddered portfolio requires long-term discipline to evaluate macroeconomic fluctuations (ie. Interest rate trends) in order to locate where they likely are in any given economic cycle. This equates to having money on hand to always pick a valuable investment that will grow above any foreseeable inflation rate and preserves capital.

The unusual thing about this meltdown is that it has created a synergy of intention among panicked and savvy investors. The frightened are scared to do anything with their money because everything they have done so far has at best provided no long-term returns (at worst bankruptcy and foreclosure), however because of the scale of the meltdown, interest rates of tumbled so low, and banks allowed to get away with so much, that even the wealthy and conservative are given pause as to where to find the best medium and long term value.

In a situation of global deflation, there may be asset class rallies like we've seen in oil and the stock market, but it doesn't mean the value of your money has been diminished, there are just as many if not more long-term gains to be made so long as you have the patience to find them.

No comments:

Post a Comment