Most of us carry the motivation to achieve financial success for one reason or other: to savour the world’s most exclusive experiences, enjoy a great life, try to change the world, or to simply leave a legacy for the ones we leave behind. As kids we are programmed to concoct a life of castles, princes and princesses riding perfect equine specimen, luxurious cars, unlimited abundance of food and drink, of fairy tales and American dreams. Then we grow up. And reality hits. We work hard and we save (as best as we can) for a never ending wish list of items, extra money for that rainy day and other savings that we put aside for travel or other long-term goals.
Historic data published by the Central Bank of Malta and other local research studies show that the vast majority of personal savings are channelled towards bank deposit accounts. But with the rate of interest at record low, this is hardly an effective strategy to accumulate wealth.
Why are banks’ interest rates so low?
The European economy, which has the greater effect on local deposit interest rates, has been passing through turbulent times over the last decade. It started with the surfacing of the European sovereign debt crisis in 2010 and continued with further shocks requiring unconventional policy measures such as negative interest rates and quantitative easing bond-buying programmes. This has pushed inflation downwards, meaning that prices of goods were rising very slowly because consumer demand was weak. The strike of the Covid-19 pandemic in March has made matters worse as thousands of workers ended up unemployed, many others had their income trimmed down and others have developed a negative future outlook. In October 2020 the European economy rebounded from the three month recession up to September but GDP remained 4.3% less than pre-pandemic levels. Now we are in the midst of a second pandemic wave, which has a stronger magnitude than the one in March and has already forced multiple countries to lockdown for at least one month. In such a scenario, bank interest rates will remain low to incentivise customer expenditure and capital investments by businesses, which will in turn help the economy to set in motion and generate employment. This is not a decision of local banks but it is the result of a complex mechanism that essentially reflects the wider economic situation. The present interest rate scenario has also impacted the Banks’ profitability for a number of reasons: negative interest rates (i.e. a cost) of placing deposits with the ECB, contribution to the Depositor Compensation Scheme, very low to negative interest earned on sovereign bonds and other low risk investment instruments and subdued demand for credit. Interest rates are forecasted to remain low for the foreseeable future and therefore bank deposits might be a poor investment for those who aspire to reach higher financial goals.
Diversifying your investments
The pivotal issue to wealth accumulation is that as adults we still embrace our childhood piggy bank saving concept, putting away some of our earnings into the bank and hardly ever considering whether we can invest it better. The main obstacle that keeps people stuck in the savings habit is their extremely low tolerance to risk. It is only natural to hold back if one does not understand the different levels of risk and the available investment options that meet the desired risk profile. Education and trustworthy financial advice are key here.
Taking the leap
When setting your risk profile, the counsel of a trustworthy financial advisor is advisable as it gives you a level of comfort based on hundreds of assessments. It is widely regarded as good practice to accumulate a reasonable reserve of cash in bank deposit accounts and then consider investing the remaining cash into some other investment options, other than bank deposit accounts. This is critical to balance your short-term goals with the medium and long-term financial goals. The amount of cash reserve varies from person to person, depending on age, other assets held, bill of health, short to medium term plans, family, employment and other matters. The financial advisor will help you establish the right amount of cash that you need available immediately in case of any eventuality.
The surplus income or bank deposits can be invested in a diversified portfolio, which is again dependent on many factors such as your life situation and risk tolerance levels. The financial advisor will help you build a personalised portfolio which will take into account a varied array of financial instruments such as bonds, shares, funds and other complex instruments, depending on the level of your knowledge and experience. You can choose to invest in local or foreign companies, select the industries and sectors which you are more comfortable with and set your exposure tolerance to the different currencies. You can also have exposure to some of these financial instruments with an insurance wrapper. This principle of diversification is a critical consideration to every investment portfolio as it helps the investor to absorb some eventual losses while making up for them with the other assets in the portfolio. Under the advisory model, you can get involved as much as you like and then consult the financial advisor before making adjustments to your portfolio. The ideal portfolio will be based on the investment objective and risk profile of the individual, allowing the investor to enjoy the desired quality of life and stay on track to reach the long-term financial goals.
Your next step
If you want better return for your money or more peace of mind about your portfolio composition, doing nothing is not an option. Interest rates are expected to remain low for the foreseeable future but there are ample opportunities for investment, even during these hard times marked by Covid-19. Learn how to make your money work better for you, make an appointment with a trusted financial advisor, explain your situation and your financial goals and evaluate ways of making your money work smarter for you.You can set up an appointment with a BOV Financial Advisor on [email protected] or call on 2131 2020.
Article was published on the Sunday Times of Malta on 15 November 2020. It was written by Daniel Magrin, Senior Analyst at Bank of Valletta.