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C & D

Risk Free Investing – Yeah Right!

We were out at a function recently, and some people were asking how safe their bank deposits were. The reason for this was because they had seen the problems in Cyprus, and the financial haircuts that the large investors were going to be victims of.

Cyprus is one of the smaller economies in the European Community. For a small country it has an inordinate number of banks. It has also attracted a lot of money from foreigners, much of which is of dubious origins. Unlike New Zealand, there was a credit guarantee in place, which covered the account holders’ first €100,000 of deposits. The Cypriot investors may lose up to 80% of their savings above the €100,000 threshold.

New Zealand had a guarantee in place for a few years following the global financial crisis. Unfortunately this also covered a number of finance companies, several of whom took unacceptable risk to further expand their business. This was an example of the “Moral Hazard”, something that we warned in one of our articles at the time, could happen when the guarantee was put in place.

The major trading banks in New Zealand are very well regulated by the Reserve Bank. They also have their Australian parent companies as further backup. While there is no guarantee in place, given the size of the banks, the term “too big to allow to fail” springs to mind. If one bank were to fail, there would be a very high likelihood that others would also fail. The financial scale of such a failure could be such that it would make the cost of the Christchurch rebuild seem small.

If an investor is extremely risk averse, then they will be very limited as to what sort of investments they could invest in. They also need to accept that bank term deposits rates at around 4.2% are relatively high given the low level of inflation. They also need to accept that the real return after tax and inflation will be minimal.

In order to enhance the return, additional risk needs to be taken. The best means is through a diversified range of investments. Safer investments are considered to be quality bonds, however the yield on these for the investor may only be marginally higher than that obtainable through bank term deposits. Only by incorporating an acceptable level of shares in the mix of investments, will the investor increase the expected return.

Increasing the expected investment return can be a double edged sword. All investing takes on risk. There is a chance of negative returns. Mathematically this is only really a problem with short term investing using riskier asset classes. Many people have the financial capacity to accept losses. What they may lack is the emotional capacity to accept for example, a loss of greater than 15%.

What this really means is that the expected mathematical returns from a portfolio for an investor are a combination of designing and implementing a portfolio that meets the investors’ comfort zone. The first step should be to take advice from an experienced well qualified adviser. Only when the investor and adviser have signed off on the level of investment risk that is acceptable, should the portfolio be designed and implemented.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.