Term deposit providers might be forgiven for saying the same thing following the RBA’s recent Melbourne Cup day commentary on savers. In fact term deposits are alive and kicking, but investors are looking again at the alternatives to a term deposit investment strategy.
It’s a timely debate. In the uncertain markets over the last two years locking in a decent term deposit rate for an extended period has been a “sleep easy” investment approach. It’s a natural and understandable reaction to higher volatility and prolonged poor equity market returns.
But as many investors are discovering it is an inflexible approach which has a potential costs associated with it, particularly real term outcomes at the end of the term.
For many investors there is a double whammy. Australia as we know is facing an onrush of investors reaching the retirement phase. These baby-boomers need investment portfolios which can adequately fund their desired lifestyles in retirement, yet many of them are retiring in an under-funded position.
In order to provide for desired income levels in retirement, growth in real terms will need to be significant enough to ensure they don’t deplete their retirement capital in short order. That trip to Europe might just have to wait.
Add to this issue the impact of rising inflation, which will erode the real value of investment returns over time. A portfolio that is primarily driven by cash rate returns has a higher likelihood of running out of money sooner than a portfolio that includes exposure to growth assets, and that’s even accounting for periods of higher volatility. Put simply, diversification matters!
But don’t get me wrong: I’m not suggesting retirees should stick it all on black and hope for the best just as they shouldn’t necessarily stuff it under the mattress. Cash and fixed income as a base are still very important and will continue to be. When global equity markets plummeted in 2008, fixed income performed very strongly, and played its important role in offsetting the negative returns from risk assets.
But as economies recovered through 2009 returns from cash and fixed income understandably fell. In the context of an income-generating portfolio those returns would have struggled to meet investor needs, whereas portfolios with investments linked to the business cycle performed strongly and recovered much of the losses of the year before. For the most part we saw investment returns in 2010 deliver outcomes much closer to our long-term expectations.
Flexibility within a portfolio is also a must. Being able to shift allocations provides the flexibility to reduce exposure to higher volatility assets – limiting downside loss – and enables returns to be enhanced when growth opportunities arise.
In our view, retirees should consider a portfolio that has a high proportion to cash and fixed income (offering liquidity, low volatility and downside protection), and is considerably enhanced with a moderate exposure to high yielding securities and inflation-protected securities across infrastructure, utilities and A-REITs.
The market’s view on cash and term deposits is that is they’re unlikely to move higher anytime soon and they are likely to go lower.
The futures market is currently suggesting that the cash rate will fall below 2.5% over the next 12 months, relegating the days of 6 per cent on a 12 month term deposit to the history books for the time being at least.
So even if you assume Australia can keep inflation within the 2-3 per cent target range it becomes clear that the income needs of retirees in the next few years will not be adequately met by cash or term deposits alone. Under that environment, taking a diversified and flexible approach across a broader set of income opportunities seems like a sensible solution to deliver acceptable income levels.
The uncomfortable reality is that if retirees fail to take a multi-asset approach to constructing a defensive income-generating portfolio for the medium- to long-term then there’s a good chance they will live long enough to regret it.
Angus Bell is the investment manager, Goldman Sachs Income Plus Fund at Goldman Sachs Asset Management
