Hawes: The myth of the safe investment

I have watched the Cyprus story with more than a little interest. A banking problem, with the solution being that depositors will take a haircut (that is, have a percentage of their deposits expropriated).

With the Reserve Bank's new Open Bank Resolution policy something similar could happen here. In a banking crisis, the Reserve Bank could effectively force bank depositors to visit the fiscal barber for a shave.

However, it is a bit worse here in New Zealand because unlike Cyprus and most other countries, there is no government deposit guarantee scheme to protect smaller depositors - the scheme initiated when the global financial crisis struck in 2008 ended in December 2011.

So, bank depositors should know that they are exposed - no bank guarantee scheme and depositors are unsecured creditors. That feeling of exposure will be lessened considerably by the fact that New Zealand has soundly managed and profitable banks which are well regulated.

Nevertheless, many Kiwis who have always valued the security of the bank (perhaps without thinking about it much) might wonder, if their bank deposits are not absolutely safe, what is?

The simple answer is nothing: there is no such thing as a perfectly safe investment. All investment means that you give your money to someone else: and as soon as you do that, there is always a chance that you will not get it back again.

Think about all of the investment types and whether there is one that you can invest in with absolute security:

Everyone knows that shares are risky - history is full of share market booms and busts. Property also carries risk: for example, Ireland property is down about 50 per cent and there are plenty of people in Christchurch who will tell you that property is not the promised safe haven.

Bonds are also volatile. Even the best issuers can default and a rise in interest rates gives a loss in value to bond investors.

Traditionally, bank deposits have been regarded as the safest, most secure store of wealth - the place where the most defensive investors put their money. However, the GFC showed (and Cyprus has underlined) that while relatively safe, they are not absolutely safe: bank depositors sometimes lose money.

This may be a banking crisis or default, or it may also be a loss in real terms because of inflation. The most casual student of economic history can give examples of bank depositors not getting their money back.

A few people would say that gold is a good store of wealth - a true investment safe haven. This is plainly untrue: the price of gold is volatile and, over long periods of time hardly keeps up with inflation.

So, there is nothing that you can do with your money that is perfectly safe - there is no place to hide. This should make you nervous - there is not a perfect way for you to maintain what you have, let alone grow it.

What, then, should an investor do? The simple answer: diversify.

Diversification is the best (and safest) store of wealth ever invented. It means spreading your money across three main things:

First, diversify across the four main asset classes. This means having some bonds, cash, property and shares. The weighting that you have to each is determined by your investor type and by your investment goals. It would only be very brave investors who had all their wealth in just one asset class, even when that asset class is bank deposits (and my high school English teacher always said that there was often little difference between bravery and stupidity).

Second, diversify within each asset class. This is to have a good spread of investments in each area to get good exposure to the overall market.

This is not just having a spread of bonds or shares, but can extend to those who have significant bank deposits.

Such people may hold their deposits with two or more different banks (say, one of the big Australian banks and another bank with a different style like Rabo or KiwiBank).

Third, diversify your investment management and advice - for example, do not use a lot of funds which come from the same manager as your KiwiSaver provider. Take advice from a range of people and listen to different points of view.

The price of safety is eternal vigilance (and even then there is no guarantee).

You can never be absolutely safe financially - but diversification is the next best thing.

Martin Hawes is an Authorised Financial Adviser and his disclosure statement is available free of charge at martinhawes.com. This article is of a general nature and no substitute for personalised financial advice.

Sunday Star Times