Its time to do something about negative interest rates

The idea of deliberately reducing your earnings so you can pay less tax brings to mind Homer Simpson’s philosophy that trying something – anything – is the first step towards failure. Is doing nothing really a better option?

I know of clients who have decided to discharge a Capital Gains Tax (CGT) bill early because negative rates on deposits mean that holding the funds in cash would cost them. You can see the logic, but it’s still hard to fathom. The idea that paying tax early is a legitimate financial planning strategy is, frankly, a sign of the times.

Negative interest rates on deposit are a very recent development but the new landscape changes the dynamics of decision-making – as anyone with an imminent tax bill will attest. So, what must you take into account?

By and large, the investment world smiles on inactivity. Your portfolio is like a bar of soap – the more you touch it, the smaller it gets. That theory, however, depends on having a robust, long-term strategy in place. For some clients, the extent of cash allocations that are genuinely surplus to short term requirements is colossal.

Although a timeless source of angst for wealth managers, surplus cash has at least always earned a positive rate on deposit – until now. By charging investors for placing money on deposit, banks have focussed minds on the ‘opportunity cost’ of not investing and, equally, the price that must be paid for doing the opposite.

Opportunity cost

The history of the stock market shows us that over the long term, a diversified portfolio with little activity stands the best chance of delivering inflation-beating returns. It’s not a sure thing, of course, and success often boils down to what the US adviser Nick Murray describes as “a battle between your need for certainty and your tolerance for ambiguity”.

Then it becomes a question of willpower. If you crave certainty, you will likely feel the need to hold more cash. But if you can tolerate uncertainty, you will probably allocate more to the stock market. It’s as simple as that.

The important thing is to do something, one way or the other. A default position to hold only cash because you are unwilling to make a decision (or take advice) has a significant opportunity cost over the long run. If you recognise and accept this cost, that’s fine. But you should not confuse the certainty of cash with security. Negative deposit returns provide no security against rising costs.

The price to pay if you do invest

There is a price to pay for reaping the rewards of investing. Returns do not come for free. Stock markets demand a price and extract that payment in the currency of uncertainty, short-term loss, regret, fear, and temptation.

It’s not enough to acknowledge this, you must be able to live with it too. Even with investing, where the link between actions and results can be drawn-out and fuzzy, you must be able to trust that the path you’ve chosen is the right one.

You can’t control the market or the outside noise, but you can control your reactions, a mindset that is inevitably helped by engaging with an adviser.

Progress happens slowly and imperceptibly. Setbacks happen fast and are hard to ignore, particularly if you are watching too closely. The price the stock market extracts appears higher if your vantage point is too close so stand back or, better still, entrust oversight to an adviser.

The price of doing nothing has gone up. Whatever you decide, accept that either way there’s a price to pay.

Talk to us about negative interest rates.