Slack growth, falling inflation, demographic challenges and low interest rates are not just persistent problems in Japan anymore: they are now everyday reality in Europe as well. In this environment, is there a danger that wealth formation and preservation will be jeopardised by zero interest rate policy? At first glance, one might think so, because "the banks are not paying any interest anymore".
Taking a closer look at the matter, however, one finds that the situation is much more complex, because wealth formation and preservation do not simply depend on the nominal interest rates offered in a single economy. It is important to make a fundamental distinction:
Wealth formation is generally made possible by ongoing income (which is independent of invested capital). In the early phase of investing, the value of the portfolio is still relatively low and the investment horizon is thus long. This makes it easier to ride out temporary losses from price volatility and compensate these via additional inflows of capital. By contrast, wealth preservation focuses on avoiding any major setbacks and maintaining the real purchasing power of the accumulated portfolio with robust returns, in order to generate current or future income.
In this regard, the principle of security (stable cash flows) puts significant limits on the goal of maximising returns. At the moment, however, risk-free returns cannot be earned, only return-free risk, such as the current German government bond with 7-year maturity and a return of zero. And there is significant price risk involved. But there are alternatives...
Wealth formation in the current situation
Assessing where you stand
First: Look ahead. Learn from the past and don’t be fooled!
It will not be possible to repeat the past returns of bond portfolios this year. Nor will investors be able to keep up with earlier returns on equities (in the last seven years, the US equity market has risen by around 100%). A well-diversified portfolio still needs to have fixed-interest instruments which are not overly sensitive to interest rates (i.e. not only long-dated paper) and a ratio of equities corresponding to the investor’s risk preference. Equities are currently profiting from the extremely low interest rates and will continue to do so in the future. But one must keep in mind that it will not be possible to avoid short-term losses on bonds and equities when interest rates start rising down the road. And don’t be fooled by high (nominal) interest rates. In the 1970s saving rates were high, but inflation (which was the reason behind them) ate up most of it and the rest was taken care of by the capital gains tax...
Second: "Don’t put all your eggs in one basket!"
Don’t bet all your money on one card: think globally and diversify. Naturally, it is fascinating to pursue trendy current investments, but a multi-asset portfolio should form the core of a saving solution, with returns that at least exceed the rate of inflation over the average of several years. An actively managed multi-asset portfolio goes beyond fixed ratios of equities and bonds, and invests in currencies, commodities, infrastructure, etc., always taking into account the predefined risk preferences. Rely on experienced investment specialists for this!
Third: Patience and focus.
Clarify your investment horizon: then you won’t have to made sudden changes when the first losses materialise. For example, rising interest rates always result in price losses on certain long-dated bonds. But in later years, you will enjoy the benefits from higher yields. With a horizon of roughly seven to ten years, you will still profit from rising interest, despite the initial losses. Even though investment funds offer daily liquidity, you should not suspend your savings plan when the stock markets fall, let alone sell the positions, because that’s precisely when additional purchases are cheap!
And one more thing: basing decisions for current investment on past returns is like driving a car by looking in the rear-view mirror. Fundamentally speaking, it is possible, but only if the road ahead is mostly straight and you drive slow. And this is probably not the best approach in the current economic situation!
Positionings refer the current situation and can change at any time without notice. They are not a forecast for the future development of the financial markets or products.
This is a marketing material of Raiffeisen Kapitalanlage-GmbH. As of January 2016
The published prospectuses or Information for investors pursuant Sec 21 AIFMG respectively as well as key investor information for the investment funds of Raiffeisen Kapitalanlage-Gesellschaft m.b.H. are available at www.rcm.at in German and – where units are sold outside of Austria – also at www.rcm-international.com in English (or German) or in your national language.