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OPINION

The Worst Investment You Can Have Right Now Is Cash

The Worst Investment You Can Have Right Now Is Cash

Cypriot Investment culture 

There is no doubt that Cypriots favourite long-term investment is cash bank deposits. We have inherited a very specific cultural mindset regarding cash, as we have been told that money in the bank through compound interest on that money is the safest and best way to riches.

Even though that might have been true in previous years where in some cases low-risk bank deposit rates could exceed 4% yield, we all know what happened in 2013 with the unprecedented bail-in of Laiki bank and the haircut of bank deposits.

Although the possibility of having another bail-in in the future is extremely low, the biggest risk to this investment thesis, which in many cases is overlooked by investors, is the current and expected levels of inflation.

 

Inflation

Inflation is a term almost everybody knows or heard of but very few people take it in to account when investing. Inflation means that the value of money will fall and will hurt those who keep cash or own cash equivalents like bonds. Inflation’s effect on investment returns is probably one of the most important factors every investor should consider before investing.

As cash is losing its value over time through inflation, one thing is for sure, cash is not a store of value over time.

Especially in Cyprus, where inflation is relatively higher compared to other EU countries, the increased cost of goods and services outpaces the returns of cash investments.

 

Cash investments returns

The two main cash investment vehicles Cypriots use are Bank deposits and, for big corporations, Government Bonds. Bank deposit rates offered by the 2 largest banks is between 0.10% - 0.12% and the 10-year Bond rates in Cyprus reached a new all-time of 0.058% on the 5th of August. Even with a return rate so low, Cyprus 10-year bond rates are the 4th highest in Europe. For example, in Germany the 10-year bond pays a negative -0.487%. The investor will actually have a negative return if the bond is held until the maturity. As for bank deposits its noteworthy that the above-mentioned rates are only applicable to bank deposits below €1mil because anything above that amount the bank charges fees to maintain a cash account. These negative interest rates it’s a relatively new economic phenomenon and economists around the world are still trying to predict its long-term effects.

 

Risk-free Return doesn’t exist

The risk-free return (10-15year government bonds) was always the baseline for comparing investments. A few years back I heard Ray Dalio saying “The risk-free return is now a return-free risk”. However, with the current returns of bank deposits and bond yields the “risk-free return” turned into a negative return risk especially when taking into consideration inflation.

 

How to make sense of all these

We are living in unprecedented times, not just in terms of the pandemic and lockdowns but also in global economic terms.

The government pursued a series of aggressive and unprecedented social spending programs in an effort to mitigate the effects of covid-19 pandemic and lockdown measures. Although these measures are considered necessary and appropriate, they will unavoidably increase the inflation rate. As John Maynard Keynes, the father of economics said “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens”.

The inflation rate of July 2021 is 4% indicating a steady increase of inflation over the last 4 months. If an investment is yielding 3.5% in a year but the inflation rate for that year is 4% there is a negative o.5% return. It is more important now than ever for investors to seek yielding investment vehicles to combat the negative effects of inflation.

 

The case for Residential property as an investment

Real estate as an investment vehicle has traditionally moved in line with inflation as both rent and capital values increase with increased inflation rates. A lot of investors use real estate investments as their no.1 choice to hedge against inflation.

Cyprus real estate is considered to be an illiquid investment as the average time required to sell an asset might take months and sometimes even years. Nevertheless, if the investor focuses on the most liquid asset class in Cyprus, which is Apartments worth between €100-200k, the illiquidity risk is greatly reduced. Almost 80% of all apartments sold in Cyprus in 2020 are worth less than €250,000. A typical apartment of this value depending on its condition, age and location can yield anything from 6% to 8% gross yield a year. That’s not considering any capital appreciation which as previously mentioned historically it moves in line with inflation over the long run.

 

Rule of 72 - Double your money

A very common exercise used when comparing different long-term investments is calculating how many years it will take for the investor to double the money invested using the rule of 72.  The rule is expressed by dividing the number 72 by the compounding interest rate number (i.e., 72/6 if interest rate is 6%).

  • Bank deposit at 0.12% -  it will take 600 years to double your money
  • 10 year CY bonds at 0.058% - it will take 1,241 years to double your money. That is not a typo.
  • Residential property yielding 6% - 12 years to double your money (+ any capital appreciation)
  • Residential property yielding 8% - 9 years to double your money (+ any capital appreciation)

That being said, investors should always diversify their investments by location, asset class and time horizon and to be always part of a holistic investment approach based on their needs and risk appetite. However, one thing is for sure, the current economic climate and central bank policies have created probably one of the best times in history to invest in cashflow positive, long term residential real estate investments and one of the worst times to hold cash in the bank or cash equivalent vehicles like bonds.

 

 

 

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