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Successful investing is about taking on risk and achieving your desired return. The base case return for most people is to beat inflation after tax. We draw on a recent report by Coronation where they unpack why taking on risk now is more important than ever, given the low interest rate environment.
For the past five years, average money market and cash-plus (income) fund returns have been 7.1% and 8% respectively. This compares with average domestic equity and balanced fund returns of 3.2% and 4.4% respectively.
Given the lower risk profile and volatility of money market and Income funds over the last five years, these funds had substantial inflows while equity and balanced funds experienced large outflows over the same period. This trend continued in 2020 despite the outlook changing significantly as interest rate returns declined significantly.
In 2020, the SA Reserve Bank cut interest rates by 3% to the lowest level in 50 years to boost the economy following the devastation from the pandemic. Although this is good for borrowers, it’s bad for savers.
It’s time to take on risk assets
According to Coronation’s view, with an outlook of low interest rates, equity markets are cheap and should deliver solid returns, beating money market returns in the foreseeable future. Similarly, a balanced fund (multi-asset: equity, bonds, property, cash) stands a far better chance of delivering better returns than money market funds.
In behavioural finance, it is a well-known fact that investors favour funds that have performed well. The converse is true here too, with poorly performing funds experiencing investor exodus and vice versa. And this is even if there are good reasons to be doing the opposite. Currently, there is a clear inflection point, where money market and income funds should provide far lower returns than the previous ten years.
The risk is that long-term investors that are allocating funds to the safety of money market and Income funds will be locking in underperformance relative to equity and balanced funds.
Investonline continues to recommend a measured phase-in to balanced funds
In March 2020 (at the bottom of the pandemic market crash) Investonline recommended a phased-in switch into balanced funds out of money market and income funds. We continue to recommend this switch, which is introducing important growth (risk) assets into client portfolios in a measured way.