In general, people are risk averse; they want to avoid losing money where possible.
For most of financial history, that meant it took a lot to persuade them out of a bank account. Why risk it in the market when you could just leave it on deposit and collect your interest?
But more than a decade of zero interest rates has led to curious change in psychology.
With bank accounts offering 0 per cent, people became much more open to taking investment risk. A guaranteed return of 0 per cent is clearly unattractive – they have nothing to lose.
Now though, interest rates are higher again. Suddenly, what they are giving up in cash isn’t zero – it’s more like 5 per cent. And so, people become risk averse and concerned about potential losses.
This has been the situation more often than not, but it feels very unfamiliar at the moment. We are certainly being asked, why bother investing at all – and from speaking to many advisers and planners, it is clear you are being asked the same question.
The current economic backdrop is enough to give any investor the jitters, let alone those new to the game. Inflation, foreign wars, domestic politics, climate change – the list goes on.
It is terrifying out there, making that 5 per cent cash return seem even more comforting.
But what we need to remind our customers is that the rise in cash rates has led to a rise in returns on all investments. Where they have money available and a longer investment horizon, putting money in cash accounts makes no sense whatsoever.
We know that we can make savings sweat much harder and generate better returns when invested. To put it simply, interest rates, no matter how high, never defeat the potential gains from investing.
Firstly, the laws of capitalism are inescapable. Governments need money, and if cash rates are set at 5 per cent, government bonds need to offer investors a better return to tempt them out of savings accounts.
And if governments want to persuade investors to lock in their savings in their bonds for up to 10 years, the return has to be worth it. Over time, government bonds have to offer better returns than cash, otherwise the wheels of our economy would grind to a halt.
When it comes to companies, they need to raise equity and debt to grow. Of course, cash is offering 5 per cent of interest, and governments are offering 6 per cent; these are safer options, so companies can only secure their funding and capital by promising higher rewards, rewards greater than 6 per cent.
Shareholders, who take on more risk than bondholders, expect much higher returns than these rates. If shareholders could fare better by leaving their money deposited in a bank account, they would simply stop investing.
