Equities best for long-term savings
Despite current turmoil in markets, investment experts stress that while deposit accounts are fine in the short term, in the long run equity funds are the best way to go, writes John Cradden
At a time when global financial markets are in what seems like an enduring turmoil, the idea of putting your spare cash into an equity-based investment product rather than a deposit account might seems like madness to the average punter.
After all, many investments have been wiped out by the sharp fall in the value of equity stocks, which seem unlikely to recover (in the short term at least) to anything like the heights they scaled before 2008.
But there persists a conventional wisdom among many in the investment industry, as well as independent financial advisers, that equity-based savings plans still represent a good option over the medium to longer term. Equities still consistently outperform most other investment categories over a longer time frame.
Keith Butler, head of business development with Acorn Life, says we all have things for which we want to save in the short term, such as our next holiday, or we want to build up some savings for the unexpected, for which a deposit account is probably the most suitable home.
"Deposit accounts are generally good for short-term saving needs, but these accounts offer unattractive growth potential," he says.
For the longer term, equity plans are the way to go, he says. "An equity-based savings plan is designed to enable you to build up a substantial sum of money over the long term. It can also provide modest levels of protection benefits, if chosen by you."
But as well as considering what you want to save the cash for, you also need to take into account your attitude to risk.
"Even with a volatile market, there are still many opportunities that exist (in equity-based products), but they're not for the faint-hearted," says Bob Quinn, managing director of Kildare-based financial advisory firm Money Advisor.
"If you are the type of investor that runs at the first sign of trouble, then you will upset the long-term returns. In this game, you should not act as a trader or speculator, simply an investor."
Mr Quinn adds that the market is currently moving towards uniform risk weighing categories ranging from one to seven, which can make it easier for consumers to compare funds in terms of risk.
So if you have a low tolerance for risk, but are willing to lock away funds for a long period, then you could opt for a low-risk, or a "cautiously-managed" fund.
However, Liam Ferguson of Ferguson and Associates warns against such low-risk equity funds.
"Typically, an equity-based savings plan has charges that have the effect of reducing your return by around 1.5pc per year or more. So to equal the deposit return, the equity-based plan would need to be providing a return of 6.5pc."
In addition, you would also need to take into account the risk premium on an equity-based plan compared with a low-risk deposit plan.
"So if we say that you should expect a risk premium of 2pc, the equity-based savings plan would need to be providing a return of at least 8.5pc per year for me to consider it good value for money," says Mr Ferguson.
He says these charges on equity plans can be expressed in a number of ways, such as policy fees, allocation rates, bid/offer spreads, etc. So if you're not sure how it adds up, try asking for the "reduction in yield", or RIY figure, which translates all the charges into a single figure, he suggests.
Interest rates on deposits are currently quite high as Irish banks desperately try to rebuild their cash reserves. But if rates were to drop, equity-based plans may become more attractive compared with deposit accounts, says Mr Ferguson.
At the moment, some of the highest interest rates on deposit accounts are being offered by the Irish banks on accounts with fixed terms of 12 months or more, ranging from Bank of Ireland at 3.95pc to EBS at 4.25pc.
There are a few other factors to consider with equity-based savings plans that could help influence your choice. If you have a lump sum to invest, you could follow it with regular contributions, using the option of euro cost averaging, Bob Quinn advises.
"In a nutshell, when you are committed to investing a set amount per month, you will have more units when the market is down (as units are cheaper) and less when the market starts to rally. This is an attempt to average out the gains and losses in the market and should stand you in good stead over the long term."
Another issue is to choose funds that match who you are as an investor. Financial advisers have a range of ways to bring these funds together, but a general maxim now is to marry together uncorrelated funds, says Mr Quinn.
"Should one fund category produce poor investment returns, you will hope that the other industries or commodities you are investing in are isolated from the negative aspects of the other."
You'll also need to think about how long you keep your funds untouched.
"If you're going for an equity-based savings plan, be sure that you can be flexible about when you're going to need your savings, in case of a market dip coinciding with your desired withdrawal date," says Mr Ferguson.
Irish Independent Supplement