Sitting on the sidelines isn’t an investment strategy

“There’s too much uncertainty in the market right now” or “I’ll hold off investing until I see how this pans out”. As investors, there always seems to be a reason not to get in the market. It’s completely natural to be a little uncomfortable when you’re taking your initial steps in your investment journey. After all, you’re transitioning from a position of comfort to one that involves risk and uncertainty. Chances are, if you feel completely fine when you’re making an investment, you’re probably not doing it right!

Now, however, one of the biggest dangers for an investor in not fulfilling their goals is inaction.

The inevitability of risk

There has always been risks associated with every asset class, from British consols in the 1700s to the latest initial public offering (IPO) on the New York Stock Exchange. When we live in the present, without the aid of hindsight, there’s no such thing as an open goal in your investment portfolio. Everything carries some degree of risk.

2020 saw the end of the longest bull run in US history. However, at every point during the eleven year rally, where the S&P500 saw 13% annualised earnings growth and 16% annualised trough-to-peak appreciation, there was always uncertainty in the market¹. 

The upside of pessimism

Pessimism often sounds a lot more clever than optimism. Optimism takes a bit more effort as it needs to be couched in facts and rational insights. Pessimists can ‘hurl on the ditch’ and throw shade on things without much factual backing. After all, even a broken clock is right twice a day.

Painting a picture of all the things that can go wrong can be more captivating. There has always been volatility in the markets, and now is no different. The media moves from one crisis to the next. We are never crisis-less.

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.” F. Scott Fitzgerald.

Any position you take with regard to your portfolio involves risk. Investing in stocks is risky. Bonds can also be risky. Alternatives, gold, private equity, hedge funds, real estate and every other financial asset involve risktaking in some shape or form.

There are no guarantees when investing in any asset class. There is no way to completely remove risk from your portfolio when you’re trying to grow your capital.

Unsafe havens

In the past, cash had connotations of security and being ‘risk free’. We have now seen a sustained period of banks offering little to no interest on euro cash deposits in Ireland. Banks have recently announced that they will start imposing negative interest rates on deposits for certain clients, bringing focus to the large cash balances that some clients hold. In reality, there has always been a cost for holding cash.

Why are we seeing negative interest rates now?

The European Global Central Bank introduced negative interest rates in 2014 as a way to encourage economic growth and stimulate to the region. Initially, Irish banks were reluctant to pass the negative rate on to customers however, they are no longer going to absorb this charge.

Figure 1: The European Central Bank deposit rate over the last 20 years

Source: Bloomberg

The opportunity cost

As an investor, this means that keeping money on deposit comes with a cost. In essence, that cost is no growth. So, sitting on the sidelines in cash guarantees that you will lose purchasing power to inflation over the longterm.

For example, an investor with €1,000,000 in 2020 who targets a gross return of 4% per annum could see it grow to €1,480,244 in 10 years. This is juxtaposed to a person who stays in cash who would see its real value eroded to €973,592 in the same time.

Figure 2: Projection of cash, inflation and a long-term diversified portfolio over the next 10 years 

Source: Davy, Bloomberg and ECB. Projections based on projected inflation of 2% per annum, target gross return of 4% per annum on diversified portfolio, negative interest rates as per market expectations (Eonia foward rates) as at 2 June 2020. All returns shown are gross of fees which may vary from client to client; Diversified portfolio based on Davy Long Term Growth Fund.

Next steps

Why not talk to your financial adviser about what your plan should be based on your own personal circumstances. Remember doing nothing might be the biggest hazard of all to meeting your financial goals. Why not request a call with a member of our team about what your plan should be based on your own personal circumstances?

¹. Source: CNBC