One of the most significant financial frustrations for individuals and business owners alike today is the very poor returns that are available for cash deposits. And it is a frustration of fairly epic proportions, as the level of household deposits in Ireland remains extraordinarily high, standing at over €148bn at the end of 2022*. Whether as a result of structured savings strategies or indeed just inertia, Irish savers continue to hold a large proportion of savings in deposit accounts.
This is against the backdrop of the last year, in which we’ve seen a complete about turn in economic policy around the world. For more than a decade we had seen an extended period of negligible and then negative interest rates, with central banks and policy makers trying to encourage economic growth through quantitative easing. In late 2021, and then reinforced by the breakout of the invasion of Ukraine in early 2022, we saw inflation baring its teeth again. The immediate response was a raising of interest rates, and tighter monetary policies. Central banks and governments today are focused on trying to bring down the high inflation, that they were previously trying to promote.
Unfortunately, increasing interest rates and high inflation tend to slow economic activity, sometimes leading to recessions. Central banks and policy makers are trying to execute a very difficult balancing act, by walking a very fine line with a high chance of missteps along the way.
The ultimate outcome of these actions will play out over many years to come. A key challenge for savers right now is that despite the increase in inflation eroding the purchasing power of their savings and investments, banks have only passed on the ECB interest rate increases to borrowers, and not to savers. Deposit interest rates remain anchored at 0% – 0.5% p.a., at least in the Irish market. In the context of inflation of 8.1% in 2022 in Ireland, and an expectation of 4-5% in 2023, savers are simply getting poorer.
Despite this backdrop, we believe there is a role for cash assets as part of an overall investment strategy. Having immediate access to an emergency fund in the event of an unexpected event is always wise. Indeed, cash also potentially plays a role as part of a diversification strategy.
That said, having worked hard to accumulate savings, we believe it is important to have your money work as hard as possible for you. So it is worth ensuring you are getting a fair return on all assets, including cash on hand.
One solution is for people to invest in money market funds. These were originally created to help corporate treasury managers maintain the security and liquidity of their cash deposits. They achieve this by pooling their assets with other investors, and lending those funds to banks, government and quasi government institutions and other corporations at money market rates. These funds are currently generating returns of 2-3% p.a. Even after paying active management and platform access fees, they provide savers and investors an opportunity to increase the returns on their cash by 1.5-2% p.a., while maintaining daily liquidity. An added benefit is they are also achieving increased diversification relative to bank deposits.
With the significant increase in interest rates and bond yields that we have seen since the start of 2022, it is also worth considering including assets such as Irish or other Euro government nominal or inflation linked bonds within the defensive part of your portfolio.
It is important to remember that the returns available on cash and defensive bonds are not matching current inflation levels and are unlikely to be the answer for your entire portfolio. However, as part of a diversified portfolio, money market funds offer an attractive alternative to bank deposits.
An observation of ours is that inertia plays a significant role in these deposits remaining in low-yielding bank accounts. Can you really afford to remain so passive with your hard-earned savings?