From Gerd Kommer and Alexander Weis
For around four years in Germany, the term “investment emergency” for interest-bearing investments has been a prominent part of the debate surrounding wealth creation among private households. It is often said that the “ordinary saver” is “downright dispossessed” by the ECB’s low interest rate policy, because the interest rates for low-risk short-term government bonds or savings deposits in Germany have been close to zero or even negative since around 2013. Saving is no longer worth it and in times of zero interest rates you have to switch to “other safe” investments with higher current returns. Some institutional investors are also complaining loudly and the insurance industry even sees itself as a victim of the ECB's “disastrous interest rate policy,” says Nikolaus von Bomhard, CEO of Munich Re.
This article is not intended to speculate about the sense or nonsense of the monetary and interest rate policy of the ECB and other central banks. We just want to soberly examine the omnipresent complaint about the “investment crisis” and “zero interest rates” on money market investments. We can anticipate the result of this examination: None of the common evidence for the alleged investment crisis stands up to critical scrutiny, just as none of the “restructuring recommendations” typically derived from it stand up to critical scrutiny. Anyone who objectively analyzes and calculates correctly would have to realize that the investment crisis that is widely lamented is largely manufactured in relation to low-risk, interest-bearing investments. We will try to explain this using five arguments.
Argument 1 – History
Savings interest or money market returns can ultimately be equated with what is known in science as the “risk-free interest rate” or “risk-free return”. [1] is referred to. In terms of products, these are “savings book deposits” (as long as they are guaranteed by a state with a high credit rating) or short-term government bonds – each without currency risk. The crux of the matter is that this risk-free return has de facto – if you calculate correctly and not selectively pick out certain periods or countries – always been close to zero or even lower, not just in the last five years. The following table illustrates this situation using the example of nine countries.
Table: Inflation-adjusted (real) money market returns (“risk-free return”) in national currency in selected countries from 1900 to 2017 (118 years)
► Returns shown are geometric annualized averages. ► “WK” refers to the two world wars. These led to particularly serious destruction of the economic capital stock, state finances and the monetary system in the four countries marked “Yes” in the right column, which is why the real money market interest rates in these countries have been extremely low or negative on average over the last 118 years. ► Taxes: A flat rate of 30% is assumed on the nominal return. ► Costs: Fixed cost of 0.2% p.a. a. assumed. ► Source of raw data (columns 2 and 3): Dimson, Marsh, Staunton: “Credit Suisse Global Investment Returns Yearbook 2018”, February 2018. Figures in column 4 calculated by Gerd Kommer Invest GmbH. ► (1) Simple average of the five countries without “yes” in the right column. ► (2) Simple average of all nine countries.
The table shows that, on a long-term average, the returns on the risk-free investment have ultimately been close to zero or even negative for many decades, assuming inflation, taxes and costs are taken into account and assuming one does not operate Data mining, so it doesn't specifically pick out certain countries or time periods to show specific results, as the financial industry and most financial media unfortunately do all the time. [2] The average values in the second lowest line of the table do not include the possible special cases of Germany, Japan, France and Austria. In their case, the national figures are distorted downwards by government bankruptcies and currency crises associated with the First and Second World Wars. But even without these four special cases, the international averages in the third and fourth columns are very low or negative (1.0% and –0.4%). The fact that individual time windows in these 118 years in each of the nine countries shown were above the values shown in the table is irrelevant in that every such above-average time window was offset by a worse, below-average time window.
If you want to treat yourself to the “luxury asset class” with the lowest fluctuations in value and the lowest stress factor, negative money market returns after inflation, taxes and costs are the historical rule and not the exception; They are by no means a phenomenon of just the last few years, as is repeatedly suggested in public discussion. Calling something that has existed for most of the past 120 years an “emergency” or “new” is absurd, and when done by representatives of the financial industry who should know these numbers, dishonest.
Anyone who is afraid of volatility (fluctuations in returns) or due to a lack of knowledge about their investments alone on the asset class low-risk money market investments limited - as many German households do - not only cannot achieve any growth in assets in the medium and long term, but will therefore suffer a gradual erosion of assets in the long term - albeit with the lowest possible portfolio fluctuations. This has always been true, not just since 2013.
Argument 2 – The Theory
Why should real zero returns, especially after costs and taxes, in the lowest-risk asset class (short-term government bonds with the highest credit rating and deposit accounts below the statutory deposit insurance limit) be considered the norm, even on a theoretical level? Simply because return is primarily compensation for risk. Where there is no expected (future-oriented) risk, there can be no positive return over the long term - at least not when inflation, costs and risk are taken into account. Why should the market pay a reward (in the form of a return) to someone who bears no risk?
A deviation from this simple basic investment law is in Review only occur if risks originally expected (priced in) by the market surprisingly do not materialize (realize). However, this favorable case is just as often countered by the unfavorable case in which the market underestimated the actual risks (originally pricing them too low based on the expected return). Then the realized real return on the risk-free investment will be even lower than the long-term average. In order to benefit from this mechanism, one would have to be able to systematically correctly predict where there will be positive and negative surprises in the future, which we consider to be impossible. For obvious reasons, sellers of actively managed investment products and strategies have of course always claimed to be able to do this. Your actual Track record suggests the opposite.
Argument 3 – The beneficiaries of the “investment crisis”
The legend of the investment crisis can also be put into perspective on another level: investors in stocks and real estate as well as debtors in general (including the largest debtor, the state - all of us) have benefited considerably from low interest rates in recent years. In the case of debtors, this does not need to be explained in more detail; There is also no doubt among equity and real estate investors that the extraordinarily high returns since the beginning of 2009 are largely due to the low interest rates. The group of stock and real estate investors together with the group of debtors probably make up more than half of the population in Germany and most other comparable countries and perhaps more than 90% of the particularly wealthy part of the population.
Argument 4 – The important advantage of low-risk investments
Money market investments - despite ultimately permanent zero interest rates - have the great advantage, especially at the present time, that in the event of a rise in interest rates, which will come at some point, they will only suffer extremely small price losses due to their short remaining term and will "take" the rising interest rates with them almost immediately (see our blog post on this). Interest rate risk). On the other hand, anyone who naively and greedily switches to one of the pseudo-alternatives with higher current returns mentioned in the following paragraph because of the supposed investment crisis runs the risk of suffering a double blow when interest rates rise in the future: sharp price declines and possibly simultaneous price declines in the risky part of the portfolio (stocks, real estate, raw materials or product packaging derived from them such as funds, capital-forming life insurance, certificates, etc.).
Argument 5 – The risk of alternatives
The switch to investments with higher current returns, which is often recommended in the context of the investment crisis, is a highly dangerous siren song that is likely to lead to unpleasant surprises in the medium or long term. In this context, consultants and the media typically suggest: corporate bonds, German “junk bonds” or high-yield bonds (here in the language they are called “SME bonds”), long-term bank bonds [3], foreign currency bonds, generally bonds with a remaining term of over five years, overnight deposits with southern or eastern European banks, Dividend stocks, loan-financed real estate investments, crowd funding, peer-to-peer lending, Bitcoin investments or gold - the eternal darling of everyone who believes in the inevitable downfall of our monetary and currency system.
Conclusion
Within a globally diversified multi-asset class portfolio - as every private investor should own - investments in short-term government bonds (remaining term of up to approximately 24 months) with a credit rating in the first four rating levels represent [4] the “risk-free” investment in the investor’s “home currency”. (Savings account deposits or overnight funds within the state deposit insurance are an almost equally good substitute.) This portfolio part has the primary, indispensable task of a security anchor to control the overall portfolio risk level.
The risk-free investment does not have the purpose of contributing returns to the overall portfolio - just as the goalkeeper in football does not have the task of scoring goals. No sane person would ever think of criticizing a goalkeeper for his obvious inability to score goals.
To the extent that the risk-free investment “coincidentally” delivers a bit of a positive return after inflation, taxes and costs in rare historical phases, we are happy about this rare gift from the market. (Rational investors are not fooled by high nominal returns anyway.) However, real returns after costs and taxes greater than zero are not a conscious primary goal of risk-free investments. The primary task of the security anchor is to be the central lever for the level of risk of the overall portfolio and to be highly liquid - nothing more and nothing less. It has already been said jokingly, but quite clearly, that the risk-free part of the portfolio is about “return of your money”, not about “return on your money”.
Anyone with the return of their In totalIf you are dissatisfied with your portfolio, you must increase the proportion of the risky part of the portfolio and reduce the proportion of the risk-free part of the portfolio accordingly - mind you, while consciously accepting the associated increase in risk. Return is the reward for bearing risk. On the other hand, converting the safety anchor in the portfolio into a risky component with a higher expected return is a dangerous and probably big mistake. It is based on the illusion that you have security and returns at the same time could have - a castle in the air that has been used by scammers in the financial sector to lure gullible private investors to inappropriate products and poor portfolio structures for decades.
Endnotes
[1] The term “risk-free” is incorrect or misleading in that a completely risk-free investment does not exist as measured by all important risk metrics (not just the fluctuation of returns). In this context, however, “risk-free” is an established term in science, which is why we also use it. The term “lowest risk” investment or “lowest risk return” would be more correct.
[2] A mistake that has been epidemic in the financial media for decades is to implicitly or explicitly generalize US data, because it is often particularly readily available, as almost automatically applying to the entire world or individual other countries.
[3] The fact that and why banks are almost without exception particularly risky debtors with regard to their liabilities from customer deposits and bank bonds is explained in Gerd Kommer, Invest confidently, Campus Verlag 2018, p. 166 ff. explained.
[4] The rating scales of the three major bond rating agencies, S&P, Moodys and Fitch, have around 25 rating levels (grades). The quality gaps between the grades (ratings) at the good end of the scale are very small, but increase drastically from grade to grade toward the poor end.