Grandma’s jam jars way to allocate investment
I’ve been told many times how good interest rates were in the 1980’s. A 6 month term deposit attracted a 15% interest rate in 1986, rising to 18% the next year. However, before we get too nostalgic, we need to understand what the real return is. If, for example, I earn 5% but inflation is 2% then my real return is 3%.
The reality of 1986 was high inflation and that, despite the 15% interest rate, investor dollars were going backwards in what they could buy, especially so once tax was deducted. The impact of inflation is to reduce my purchasing power. To earn a real return is to maintain and grow it.
Skip forward to 2006 and the rate was 7%. Inflation however was only 2.6%. The interest rate was lower than 1986 but the real return significantly improved. Our dollars were holding their value and more.
Today 1.5% is a more likely rate. Deduct tax and we will again be struggling to earn a real return. Equally concerning is the distinct possibility that interest rates will stay lower for some time and may yet go lower still. We all need to plan our investments for a new normal.
Key to this is what mix of income and growth investments you own. This has always been important. Now it is more so. In 2006 the real return from interest rates was sufficient that I could be overly cautious and my retirement wealth continued to grow at a reasonable rate. But with income returns low, by necessity a higher allocation to growth investments becomes a really important discussion topic – whether I am building for retirement or am already there.
If I am in my 40s or 50s, as an example, and saving for my retirement I should likely have an allocation to growth investments, such as property and shares, higher than to income investments such as the bank and bonds.
And if I am in retirement, to rely solely on cash and term deposits at current rates is to increase the risk that I might run out of funds while I still need them.
How to have more in growth investments but still sleep well? One potential answer is of Grandma and her jam jars. Grandma budgets by allocating money to the different jars – for food, rent, entertainment. We can apply the same concept to allocating our investments.
What are our investment jars? They are the spending we will do each year into the future. The first jar will be our funds to spend in the next 1 to 2 years. Return is not our top priority. Flexibility and stability are. Bank deposits are the appropriate choice. The choice for spending in years 2 to 5 could be a diversified income investment. Relatively stable but with a bit more return potential. Years 5 to 10 might be a well diversified fund with a 50% share allocation. And lastly, having taken care of our likely expenditure for the next 10 years the last jar can be fully growth orientated – a diversified share investment being an example. Our investments are matched to our spending and within that appropriate time periods to reduce the risk of having to sell any investments at the wrong time.
We all need growth. Attaching labels to groups of funds which have different purposes and timetables, creates a separation in our minds, giving us additional comfort and the opportunity for better outcomes.
The reality of 1986 was high inflation and that, despite the 15% interest rate, investor dollars were going backwards in what they could buy, especially so once tax was deducted. The impact of inflation is to reduce my purchasing power. To earn a real return is to maintain and grow it.
Skip forward to 2006 and the rate was 7%. Inflation however was only 2.6%. The interest rate was lower than 1986 but the real return significantly improved. Our dollars were holding their value and more.
Today 1.5% is a more likely rate. Deduct tax and we will again be struggling to earn a real return. Equally concerning is the distinct possibility that interest rates will stay lower for some time and may yet go lower still. We all need to plan our investments for a new normal.
Key to this is what mix of income and growth investments you own. This has always been important. Now it is more so. In 2006 the real return from interest rates was sufficient that I could be overly cautious and my retirement wealth continued to grow at a reasonable rate. But with income returns low, by necessity a higher allocation to growth investments becomes a really important discussion topic – whether I am building for retirement or am already there.
If I am in my 40s or 50s, as an example, and saving for my retirement I should likely have an allocation to growth investments, such as property and shares, higher than to income investments such as the bank and bonds.
And if I am in retirement, to rely solely on cash and term deposits at current rates is to increase the risk that I might run out of funds while I still need them.
How to have more in growth investments but still sleep well? One potential answer is of Grandma and her jam jars. Grandma budgets by allocating money to the different jars – for food, rent, entertainment. We can apply the same concept to allocating our investments.
What are our investment jars? They are the spending we will do each year into the future. The first jar will be our funds to spend in the next 1 to 2 years. Return is not our top priority. Flexibility and stability are. Bank deposits are the appropriate choice. The choice for spending in years 2 to 5 could be a diversified income investment. Relatively stable but with a bit more return potential. Years 5 to 10 might be a well diversified fund with a 50% share allocation. And lastly, having taken care of our likely expenditure for the next 10 years the last jar can be fully growth orientated – a diversified share investment being an example. Our investments are matched to our spending and within that appropriate time periods to reduce the risk of having to sell any investments at the wrong time.
We all need growth. Attaching labels to groups of funds which have different purposes and timetables, creates a separation in our minds, giving us additional comfort and the opportunity for better outcomes.
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Stephen McFarlane is an adviser with NZ Funds Private Wealth in Timaru. The opinions expressed in this column are his own. A copy of Stephen’s Disclosure Statements are available on request, free of charge.
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First published in the Timaru Courier on 10 September 2020, as 'Grandma’s jam jars way to allocate investment.'
