|        About Good Returns  |  Advertise  |  Contact Us  |  Terms & Conditions  |  RSS Feeds

NZ's Financial Adviser News Centre

GR Logo
Last Article Uploaded: Saturday, July 13th, 10:20AM


Investment News

Bollard tells people to seek advice

Reserve Bank governor Alan Bollard is warning investors about risks in fixed interest products as well as real estate.

Thursday, October 16th 2003, 8:52PM
Leaving real estate aside now, what other investments are available, and how does low inflation affect the equation? After bank deposits, probably the most commonly understood financial security is equities. History shows that equities can deliver a superior long-term rate of return, but also that equity returns over short periods of time can fluctuate quite a bit. New Zealand investors tend to know this, having suffered in the 1987 crash, and have been rather cautious ever since. This caution and the small size of the domestic market, which limits local options, have contributed to New Zealand households not building up financial assets to the same extent as has happened in the US. However, it has also meant that New Zealand household balance sheets did not take such a hit from the tech-wreck and post-9/11 downturns in the markets.

Investors in equities should be in for the long haul, to allow time to smooth out the inevitable fluctuations in share prices that occur from year to year. Also, because you can never be sure about any particular company, industry or region, if you are buying shares you should spread your investments across a diversified range of equities.

What about interest-bearing securities? One of the consequences of reducing inflation to low and stable levels is that nominal interest rates on all types of these instruments have fallen substantially. As an example, the average 90 day interest rate in the 1970s was just over 10%, and in the 1980s was around 17%. In the 1990s, the rate fell to 8%, and today stands at a little over 5% - the lowest in many years. Interest rates on other instruments have fallen similarly.

In real terms, of course, interest rates have not fallen anywhere near as substantially over the years, and remain attractive for investors, particularly relative to the real interest rates available in many other countries. Indeed, the real interest rate on interest-bearing securities today is considerably higher than was typical during the high-inflation times in the late 1970s and early 1980s. Taking tax into account widens the gap even further, because tax rates are applied to nominal, rather than real, interest income.

Investors in interest-bearing securities are thus better off now than they once were. But people who rely heavily on interest-bearing securities for their incomes have nevertheless seen a fall in their incomes, in nominal terms. I fear that this reduction in nominal income, coupled perhaps with "money illusion" - that is, thinking in nominal rather than real terms - may be encouraging some New Zealanders to invest in higher yielding securities, in order to reduce the short-term impact on their cash flow position.

In this drive to achieve higher rates of return, some investors may be taking higher risks than they appreciate - especially if they think in terms of the nominal interest rates that they used to receive in earlier years. For example, just a dozen years ago, low-risk securities regularly offered double-digit interest rates. Today, an equivalent low-risk security might only yield 5 or 6%, or even less. To invest in securities offering the same nominal yields as were once available, investors now have to accept considerably greater risk.

Perhaps reflecting this behaviour, deposits outside of the banking sector are growing quite rapidly. There are also reports of growing retail investment in higher-risk types of securities such as subordinated notes, capital notes, asset-backed securities, and interests in apartment buildings. These and other kinds of more complex investment products typically offer high yields, but that usually reflects higher levels of risk. For example, it may be that the investment ranks behind other debt obligations of the borrower, exposing the investor to a greater risk of loss if the borrower defaults. In other cases, the yield being offered may be linked to the performance of particular underlying asset markets, which may themselves be quite volatile.

There is, of course, nothing inherently wrong with investors taking greater risk. For their own protection, however, they should be fully aware of the risks they are taking, rather than simply thinking in terms of the nominal interest rate offered.

Given all this, what should a wise investor do?

First of all, seek advice! This applies especially if an investment product looks complicated. There are many sources of information to assist in making investment decisions, including material published by public agencies such as the Office of the Retirement Commissioner, and by reputable members of the savings and investment industry. There is also the advice of professional experts. Naturally, the quality of advice is only as good as the quality of the person giving it, so if an investor chooses to use an investment adviser, the investor would be wise to check the adviser's qualifications and accreditation, experience, track record and independence.

Checking the provenance of investment products and firms is all the more important in New Zealand because regulation of financial investments here is not highly paternalistic. The general approach of the Reserve Bank Act for bank deposits, of the Securities Act for financial securities, and of legislation for other forms of investment is to promote the proper functioning of the financial system as a whole, and not the performance or soundness of particular institutions. Laws relating to the financial system set extensive and tough disclosure requirements, so that individual investors can judge for themselves the risks and returns they are facing and make decisions accordingly. As noted earlier, low and stable inflation supports their ability to do this.

Investors not prepared to be intensively involved in the day-to-day management of their investments have the option of engaging a professional to manage directly their financial affairs. There are many professional investment management services available. Although some professional service arrangements are pitched at those with sizeable sums to invest, there are also management services for those making smaller investments. Finally, managed-fund products such as unit trusts offer the smaller investor a combination of reduced risk through diversification, and the portfolio-management services of an investment professional.

Vigilant and open-eyed investment strategies benefit not only investors. Households making well-informed investment and borrowing decisions are better able to cope with rainy days, and better prepared for their retirement years. Soundness in the household sector undergirds the stability of the financial system, and of the economy as a whole. Finally, intelligent scrutiny of investment proposals, including the creditworthiness of financial companies, crucially helps weed out poor performers and improve good performers, promoting effective resource allocation and growth across the economy.

For all these reasons, it is important that investors take all the steps they can to better understand the nature of the risks attached to their investment and borrowing decisions. This includes thinking in terms of real rates of return, rather than nominal rates. If we - each of us - can learn to become smarter and better informed, we will all be better off, individually and as a nation.

This is part of a speech Reserve Bank governor Alan Bollard made to the Auckland Club and the MBA Business Meeting Auckland earlier this week.
« Share markets - where to from here?Fund manager performance »

Special Offers

Commenting is closed



Printable version  


Email to a friend

Good Returns Investment Centre is brought to you by:

Subscribe Now

Keep up to date with the latest investment news
Subscribe to our newsletter today

Edison Investment Research
  • Martin Currie Global Portfolio Trust
    11 June 2024
    Manager ‘sticking to his knitting’; positive outlook
    Martin Currie Global Portfolio Trust (MNP) has been managed by Zehrid Osmani since October 2018. He runs a high-conviction, relatively concentrated portfolio...
  • SDCL Energy Efficiency Income Trust
    10 June 2024
    Answering five key investor questions
    In this note we examine five key questions investors have raised regarding SDCL Energy Efficiency Income Trust (SEEIT), prior to the release of its full-year...
  • Invesco Asia Trust
    4 June 2024
    Patiently waiting for re-rating of Chinese equities
    Invesco Asia Trust (IAT) posted a one-year NAV total return (TR) to end-May 2024 of 3.8%, below its benchmark return of 8.7%, as some of IAT’s Chinese...
© 2024 Edison Investment Research.

View more research papers »

Today's Best Bank Rates
Rabobank 5.25  
Based on a $50,000 deposit
More Rates »
About Us  |  Advertise  |  Contact Us  |  Terms & Conditions  |  Privacy Policy  |  RSS Feeds  |  Letters  |  Archive  |  Toolbox  |  Disclaimer
Site by Web Developer and