Who took the carbs out of my investments? Saving in a low-return environment

01/12/2016

Whether in the media or in presentations and comments from financial professionals, the term ‘low-return environment’ seems to be the flavour of the month.

This does not sound that appealing – a bit like a low-carb diet one might say. Is this a short-term issue, or should savers consider this as a long-term challenge that might leave them hungry for returns? In this article, Noah Schiltknecht from our investment adviser and consultant Russell Investments shares some thoughts on the current situation and what members should expect in the coming years.

The easiest way to understand the low-return environment is to look at interest rates. Ten years ago, you could get close to 10% at the bank in New Zealand, but now you might only get 2%. As a result, your savings won’t grow as fast as they once did by storing your money in a bank account.

And since investors typically assess the attractiveness of other investments relative to cash returns, expected returns for other assets like bonds and shares have fallen as well. In some cases, like in Japan and many European countries, interest rates on cash and yields on bonds have even fallen below zero. What is driving rates so low? There are numerous reasons, but we believe two are worth highlighting in particular: lower growth and lower inflation.

Ten years ago, the world economy was steaming ahead. Unemployment was low, and growth rates were high. As a result, inflation started to rise. In New Zealand, the Reserve Bank increased interest rates in several steps to combat the inflationary pressures. But then the world was confronted with the global financial crisis. Share markets dropped sharply, unemployment rose and economies went into recession.

Growth outlooks were suddenly depressed, and investor confidence was at multi-year lows. Concerns about high inflation were replaced with worries about deflation (falling prices).

To kickstart the economy and increase confidence, central banks around the world started to use unprecedented monetary policy (commonly known as quantitative easing). As a result, interest rates fell sharply. At the same time, the slow but steady economic recovery in the United States led to a multi-year positive run in share markets. But it also created a new baseline for investors today. If cash is not returning much or nothing at all, one should, based on the historical return difference, expect that other assets like shares will return a lot less than 10% as well.

But didn’t we just have several years of double-digit returns for investors? This is where the old words of caution in financial markets are as important as ever – ‘past performance is not necessarily a good indicator of future performance’. Much like when driving a car, looking into the rear-view mirror is not the right way to think about what to expect in the future. As an investor, you should look forward rather than at historical returns.

In the current environment of low returns and tepid growth, most market participants believe that interest rates will not rise rapidly around the world for a considerable amount of time. Savers need to take this into account. While we cannot rule out a positive surprise, a sensible approach may be to budget for lower returns over the next 5 to 10 years. Depending on your goals, this might result in you needing to save more or to reconsider your tolerance for risk.

While one can’t expect savings to grow as fast as they have in recent years, it is still worthwhile considering investing in a diversified portfolio to get some extra returns over time. Low returns are not a reason to stop saving or investing at all. It is better to eat a low-carb diet than stop eating completely.
 

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