Savers need savings tools... not market risk

Savers need savings tools... not market risk

Much “investor education” involves persuading savers that they need to invest in listed equity assets in order to build their wealth. This is outdated advice.

The argument is that long-term wealth accumulation, to fund long-term liabilities such as retirement or childrens’ education, needs higher returns (and therefore higher risk) than simple bank savings will provide. In principle, this makes sense: incremental return requires incremental risk. But the financial services industry then makes a blue-sky leap across logic, by nudging savers towards stock market investment, mutual funds, and equity ETFs, as the default “risk” investments.

This is the financial services ecosystem pushing its wares. When a stock exchange talks about “investor education”, what it means is that it would like more individuals to trade stocks.

Ditto, of course, an ETF provider or a mutual fund manager; they would like more customers.

A generation ago, savers looking for growth from financial assets had little choice but to invest in market risk. And over that generation, savers would have done well assuming they’d stayed invested for a long period of time. If I’d bought the MSCI World index the day I started work in 1985, my $100 investment (all I could have afforded then!) would now be worth more than $600.

But… during that time there would have been more than half a dozen periods of 5 years or more when I’d have been better off holding cash in the bank. There would have been market crashes of 40% or more that might have panicked an inexperienced investor out of the market. And my impressive-sounding total return only represents about a 6% annualised rate of return; I remember that, back then, typically financial planners were allowed to talk about 7%-15% rates of return for equity investment. Therefore, if I’d been saving for a specific outcome, I might not have achieved my investment goals in any case. Furthermore although standard deviation is lousy measure of risk, for what it’s worth, the market’s standard deviation would have been in the mid to high teens – not attractive for the return achieved.

Stockmarket investment in general is not a consistent enough approach for non-specialist savers.

Looking at this from a different perspective: the ideal investment is one whose return profile matches the liability profile of the investor. Returns match the underlying needs. And I challenge you to list any investors whose liabilities correspond to stock market movements! Almost everyone’s liabilities can be defined in absolute amounts ("I will need $300,000 in 15 years' time to pay for college education"), or in nominal increments ("I know I need to make an average of 5% per year to achieve my goal"). Stockmarket investment does not offer these parameters. It is a very poor proxy for investor needs.

Alternative investments typically aim for a consistent positive rate of return; in other words, they aim to make you money, consistently. One of the features of the alternative investment world is the sheer variety of products out there, and the fact that it’s impossible therefore to generalise about investment returns. But it’s easy to find products with a much more attractive risk-return profile than simple market investment.

A typical long-short equity hedge fund might aim to make 2/3 of the market’s return, taking only 1/3 the risk. This would be much less likely to panic an investor out of the market in a downturn, and overall lead to a stronger risk-adjusted return profile than the market.

A typical private equity product might offer return in the range of 5%-15%, deliverered over a medium time horizon. Well-run private equity should offer moderately higher returns than equities, over time periods that suit many investment objectives.

A typical REIT might offer a running yield significantly higher than cash deposits, with good liquidity, and mitigated exposure to equity market beta; in other words, a sensible alternative to a conventional equity + bond mix.

Alternative investments may look complex, and the management of some certainly are complex. But the outcomes they deliver are what most investors need, much more so than simple market exposure.

Alternative Investments... deliver what most investors need.