Investing in Cash can be risky too!

February 14, 2013

Matt Richardson

At the time of writing, Peter Cramer and I are currently at the Self-Managed Superannuation Association of Australia (SPAA) National Conference. One of the recurring themes in several of the sessions on the first day of the conference is the issue facing members of Self-Managed Superannuation Funds (SMSFs) who are currently accessing their benefits as a pension. In short, they are not generating enough income.

A typical school of thought over the years is that when taxpayers retire or wind down from their working life and start relying on their investments to provide their income, they should be looking at investing a significant component of their assets in fixed interest deposits because this is less “risky”. But, is it really less risky?

The risk that is referred to in this sentence is volatility risk. The concept of volatility risk has been highlighted significantly over the last 5 years where we have seen the value of stocks on the Australian Sharemarket fall. The All Ordinaries Index, which is a measure of the performance of the ASX, has only just gone past 5,000 points which is still significantly under the peak from November 2007 of 6,873 points. In many cases, after taking into account the reinvestment of dividends over this time, investors are only just now seeing their capital return to the same levels as 5 years ago.

What investors need to understand is the risks they are facing if they continue to invest the majority of their savings in cash or fixed interest deposits. There are 2 risks, as follows:

1. Interest rate risk – this is where the investor, who is relying on interest on their deposit to provide their disposable income, is effectively at the mercy of the bank institutions and the Reserve Bank interest rate policy. At the time of writing a 12 month Term Deposit will be offering a rate of around 4.15%, compared to an interest rate approx 20 years ago of 12%. Today, on a deposit of $100,000 this would produce income of only $4,150. In summary your income levels are not growing and eventually you will have to bite into your capital to maintain your required income for living purposes.
2. Inflationary risk – this is an easy one to understand. If you had $100,000 invested 25 years ago, you would still only have $100,000 today. After taking account the effect of inflation, $100,000 today buys approx 25% of what it purchased 25 years ago.

There are alternatives to cash deposits which can include investments in property and shares. Investments in these areas will normally have significantly better prospects of generating an income which will grow over the years with inflation. One important fact is even since the GFC, over the last 5 years a large percentage of ASX top 50 stocks have continued to increase their dividends as well as over the last 25 years. Another bonus with receiving fully franked dividends in an SMSF is the franking credits will be fully refunded on top of the dividend. (Please ask us how this works – it’s powerful stuff!)

Shares and property are not for every investor, however I just want investors to understand that investing in cash can also carry some risks. If you want to know more about the tax impact or characteristics of different types of investments, please contact us at Green Taylor Partners.

DISCLAIMER: This is general advice only and should not be considered financial advice. Investors should obtain appropriate financial advice which takes into account their overall individual circumstances from a suitably licensed financial planner prior to making any investment decision.

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