Why investors pay a heavy price for bank deposits

Having clients believe that placing money in bank deposits constitutes investing will have a detrimental effect on both the financial advice industry and the end consumer, according to Phil Galagher.

When the financial services sector was developing as a major force a couple of decades ago and changing the face of wealth accumulation and management for Australians, it was very successful in convincing Australians that saving was not investing.

Financial planners and fund managers alike did a good job in persuading Australians that leaving money in bank accounts was not a good long-term wealth building strategy.

It was a convincing argument, and largely turned Australians from a nation of savers to a nation of investors.

However, in recent months the distinction between ‘investing’ and ‘saving’ has become blurred, which must be to the detriment of those looking to create long-term wealth.

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At the moment, Australians are being led to believe that leaving money in bank deposits is the same as investing.

This change in attitude started in the wake of the global financial crisis (GFC) and was reinforced with the American and European debt crises that followed.

The ‘double whammy’ of these events resulted in investors throughout the world, including Australia, losing their appetite for risk.

As a result of the general mood of risk-avoidance, there was a significant move by investors into cash such as term deposits. This attitude was reinforced at the time in Australia by the bank guarantee.

Today, we are even seeing expert commentators talking about “investing in cash”.

This should concern financial planners who are looking to encourage clients to adopt long-term investment strategies to build wealth and trying to get them to understand the difference between saving and investing for growth.

Clearly, wealth left in interest-bearing bank accounts is not investing, it is saving – or, putting the best light possible on it, preserving capital.

We need another round of persuasive arguments from the financial services sector that explains investing means taking on some risk (albeit risk that is managed) to grow wealth and increase capital. Leaving money in cash will not achieve this.

In the current circumstances of falling interest rates, where inflation continues to erode capital value, investors need to understand the impact on their wealth – and on their long-term plans – that leaving their assets in cash has.

If nothing else, investors need to be encouraged to understand the impact of inflation, so that when they calculate their returns from cash deposits, they reduce them by the inflation rate to give a true return.

With the current sea of negativity swamping us all, and the ever more demanding regulatory requirements, it is understandable that financial planners are feeling very constrained in their ability to encourage clients to look at growth assets.

The outlook for Australia is still impacted by major concerns about the European, US and Chinese economies, all of which have a major influence on local markets.

It is also perfectly understandable that many investors remain very concerned about the risk to capital of investing in growth assets in the current market environment.

However, we still need to convince long-term wealth accumulators that they should not become paralysed or self-deceiving because of short-term concerns.

Investors must be encouraged to keep a sense of proportion and balance, as well as have an appreciation of alternative approaches, including long-term risk management, so that this balance is taken into account in their approach to wealth accumulation.

They must appreciate that term deposits will not lead to wealth accumulation and that, at best, such approaches only preserve capital at existing levels. A balanced portfolio that includes growth assets must still be considered by long-term investors.

Perhaps the present yield situation can be used to further this point of view.

In the current circumstances there is a powerful argument for investors to consider high- yielding blue chip stocks to add some growth to their investment portfolio and manage risk, as well as providing tax- enhanced yields that are more attractive than the returns achieved by leaving cash in a bank.

This approach exposes investors to fairly low-risk equity investments in long-term assets, in keeping with a conservative wealth accumulation strategy.

Apart from anything else, I firmly believe that in five years time investors who are not now in the market will look back at equity prices today with regret.

Even investors who still want no part of equity markets at the moment need to understand that there are alternatives to term deposits that they could consider.

In looking at diversifying the cash component of portfolios, there are a variety of bond approaches that will give better yields over time than cash – including recently available corporate bonds.

Again, these offer very low risk to investors who hold the bond for their full term.

Another investment that has been unfairly tarnished since the GFC, and introduction of the Australian bank guarantee, is mortgage funds.

There are alternatives to leaving investor cash in a bank and investors must be encouraged to understand that short-term fear should not freeze long-term growth strategies,  that saving is not investing and that preserving capital is not wealth accumulation.

Phil Galagher is head of wealth management and marketing at Equity Trustees.