Be careful avoiding risk

I remember having conversations with clients in 2008 & 2009 during the last global crash and subsequent recession about being careful running away from one risk into the arms of other risks.?Back then many people were worried about the security of their bank deposits across Europe as the Greek economy was going into a tailspin and had to be bailed out by the IMF. We had a similar situation here with the controversial bank guarantee on all deposits & bond holders back in 2009 of course. Back then some of my colleagues’ clients requested their cash deposits to be switched out of Euros and into other currencies such as the Canadian dollar, Australian dollar and the Swiss franc. People feared the whole Euro project and currency could fail and their savings would either be devalued or else disappear altogether. In hindsight, these fears were overdone, but it can be hard to see through the storm when you are surrounded by it.

There are many types of risk and what those depositors often didn’t grasp back in 2008/2009 was that currency risk is also a fact they should have considered. If you live in Europe then you’re going to need much of your cash deposits to be denominated in Euro, because that’s what you require for your day-to-day spending. Some of those depositors lost significantly on their capital when the storm had passed, and they switched those foreign currencies back into Euro. Inflation risk is another concern for many depositors right now as the price of so many things is now rocketing. Fuel and the cost of energy is going to remain a big problem for many consumers and businesses as the Ukraine situation continues without an obvious solution on the horizon. Official inflation figures here in Ireland pitch it at around 5.5% which is the cost of a basket of defined goods today versus what they cost twelve months ago. That’s how inflation is measured in economies; it’s the rate of growth year on year, or month on month etc. UK and US inflation figures are even higher, and I would think Irish inflation has been closer to 7 or 8 per cent for quite a while now.

The direct risk of inflation to savers is that if inflation is, let’s say 7%, then your savings will buy you 7% less than you could afford this time last year. In economics it’s called your Purchasing Power Parity. In simple terms, if you had €100 today and inflation stayed at 7% for 3 years then your €100 at the end of the third year would only be able to buy you €80.44 worth of the same things. So, your purchasing power parity has been significantly eroded. This wouldn’t be such an issue if deposit rates were back to their ‘normal’ level of around 4% as you’d be earning this each year if you left your money in the bank. However, deposit rates are negative, so this is compounding the damage to your savings in the bank or credit union. The remedy to maintaining your buying power with your savings is to take some risk and invest some of your savings to try generating a positive return. It’s unlikely but let’s say inflation stayed elevated for 5 years at a rate of 6%, i.e., prices keeping rising by 6% every year, then your €100 would have lost €22.62 of its value and only be worth €77.38 in buying power.

I don’t want to scare anyone into investing their savings, but all depositors should be aware of the dynamics of high inflation and how it can impact their longer-term plans for educating their children, retirement savings etc. Knowledge is power and simply opens your eyes to options available to you. If you would like to discuss an investment and savings plan, then I’d be delighted to help show you what options are available. It’s always smart to have a plan.

"In simple terms, if you had €100 today and inflation stayed at 7% for 3 years then your €100 at the end of the third year would only be able to buy you €80.44 worth of the same things".