Your Smart Money: Negative interest - What to do with your savings?
One unusual phenomenon which has arisen during the Covid-19 Pandemic is the willingness of Irish household to save money.
While the lockdowns have no doubt been very difficult for many people, there are also those who have rediscovered the habit of saving.
The pandemic restrictions meant some households, that weren't impacted by loss of income during the pandemic, put money aside that they would ordinarily have spent in the wider economy.
Recent reports from the central bank state that Irish household Deposits reached a record high level of €125 billion at the end of 2020. That’s an increase of €13 billion during 2020.
To put this in context, this is more than was saved during the entire five years of the government backed SSIA scheme in the early noughties.
It is somewhat ironic that this savings boom has come at a time when interest rates are at record low levels. Since as far back as 2014, Irish banks have been charged for placing their deposits with the European Central Bank and it was inevitable that at some point they would start to pass this cost on to their customers.
The banks claim they can no longer absorb the cost of keeping customer money on deposit and must therefore pass on the charges. Bank of Ireland charge negative rates to specialist accounts such as pension funds as well as SME’s with deposits over a certain threshold.
AIB also charges negative rates to certain SME businesses while it has cut rates on most personal accounts to zero. Credit Unions are also being charged for lodging their own customers' deposits into the banks. This explains why many have now started placing limits on individual deposits from their members.
So, what should you do if you’re one of those who find themselves with money on deposit earning zero return? Start by taking a detailed look at your current financial situation.
Is there expensive debt such as a credit card or car loan where it might make sense to pay it down early? Paying down a mortgage early does not always make financial sense, especially if you’re fortunate enough to have a tracker rate.
Next, ask yourself, do you have an emergency fund? An emergency fund or ‘rainy day fund’ is a pot of cash that may be needed to cover anything unexpected. It should always be liquid and easily accessible and as a general rule of thumb it should contain the equivalent of between three and six months nett income.
For any funds remaining it could be the appropriate time to consider your investment options. To counteract negative or zero interest rates, investors will have to consider moving some of their cash out of banks deposits and into assets such as equities, fixed interest alternatives and property.
Firstly you need to determine your risk profile and time horizon. Ask yourself whether you’re a long term investor or a short term saver. For example, if you’re in your 40’s and have €100,000, you’d be well advised to take your money out of a deposit account and explore your long-term investment options. However, if you’re 25-years-old and are saving for next year’s holiday, then a deposit account may be a viable option. It all depends on your short- and long-term financial objectives.
Many well- known life assurance companies have introduced “easy access” savings and investment contracts in an effort to attract those customers unhappy with deposit rates.
These contracts generally offer a wide range of funds across the entire risk spectrum. This type of investment offers customers diversification across asset classes which is also very important.
Investing in these type of managed funds should only be considered by investors who are willing to leave their cash invested for number of years andas these are investments and not deposit accounts, they inevitably involve some level of risk.
Risk and reward go hand-in-hand for investors, so it is important for individuals to determine what level of risk they are comfortable with.
Inflation is another factor which those on deposit should be concerned about during this type of low interest rate environment. Your nett return needs to consistently beat the prevailing rate of inflation in order to get a real return on your money.
Fortunately, the inflation rate is relatively low at the moment however the long term target inflation rate across the Eurozone is 2% which means leaving your money on deposit for the long term will most likely erode its real value over time.
Seeking independent financial advice is a must for anyone considering moving off deposit. Why? Banks and building societies may have a vested interest in keeping your funds on deposit or selling you their products, which means that their advice is rarely impartial. Whatever your situation, it looks like this Zero interest rate environment will continue for a number of years therefore It pays to make yourself fully aware of your long-term investment options.
Barry Kerr is the Founder & Managing Director of Wealthwise Financial Planning who have offices in Carrick on Shannon, Co Leitrim & Oranmore Co Galway. All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland #CI6614. www.wealthwise.ie firstname.lastname@example.org