Opportunity Cost Of Staying On Sideline
Ayear after the Covid panic markets crash in March 2020, investment brokers have great performance data to wave at funds investors. At Zurich Life for instance, the one-year gross gains are stellar across multiple equity funds in the date range from mid-April 2020 to mid-April 2021. Some examples: Prisma 5 (+38%), Prisma Max (+42%), 5 Star 5 Global (+57%), 5 Star 5 Europe (+47%), Eurozone Equity (+50%), Irish Equity (+62%), and Indexed Top Tech 100 (+53%).
Equity prices have been on a rip for the past year, and show no sign of slowing down. Gary Connolly, investment director at Davy, acknowledges that the last 12 months have been an extreme outlier, pointing out that there hasn’t been a similar 12month bull market since the 1930s.
The annual gains detailed above are date specific. Investors who bought into those Zurich funds in February 2020 would have been underwater until November. Sooner or later, according to conventional wisdom, the bubble will pop and equity prices will retrench. Nobody knows when that will happen, and with no end in sight for deficit spending in America and elsewhere, lucky investors will be inclined to hang on for the ride.
Meanwhile, the majority of Irish savers have their money parked in cash, earning no income. In February 2021, household deposits reached an historic high of c.€128bn, increasing by 14% year-on-year. The Central Bank says this is the highest annual increase in household deposits since the series began. People are parking their income in the bank because they can’t spend it, and most are too risk averse to take a chance with the markets.
If the deposit is over a certain size, banks charge customers for the privilege of minding their money. In Connolly’s view, by charging investors for placing money on deposit, banks have focused minds on the ‘opportunity costs’ of not investing, and the price that must be paid for doing the opposite.
Investment experts like Connolly concur that over the long term a diversified portfolio with little activity stands the best chance of delivering inflation-beating returns. However, every investor faces a battle between their need for certainty and their tolerance for ambiguity.
Connolly adds: “Then it becomes a question of willpower. If you crave certainty, you will likely feel the need to hold more cash. But if you can tolerate uncertainty, you will probably allocate more to the stock market. It’s as simple as that. The important thing is to do something, one way or the other.
“A default position to hold only cash because you are unwilling to make a decision or take advice has a significant opportunity cost over the long run. If you recognise and accept this cost, that’s fine. But you should not confuse the certainty of cash with security. Negative deposit returns provide no security against rising costs.”
Connolly’s opinion is true to a point. The vast majority of depositors aren’t charged for leaving their cash in the bank. Last year was marked by price deflation, and the Consumer Price Index reading for March 2021 was 0.0%. So money left on deposit isn’t losing purchasing power at the moment, though it’s not providing income or wealth growth either.
Connolly acknowledges that there is a price to pay for investing, referencing uncertainty, short-term loss, regret, fear and temptation. “It’s not enough to acknowledge this – you must be able to live with it too,” Connolly advises.
“Progress happens slowly and imperceptibly. Setbacks happen fast and are hard to ignore, particularly if you are watching too closely. However, the price of doing nothing has gone up. Whatever you decide, accept that either way there’s a price to pay.”