A lot of pensioners who have recently lost their aged pension, or where their assets were just above the old thresholds are in a dilemma. If they use very safe and stable investments such as term deposits or cash at call they only earn around 2.6% in interest at the moment.
If you are a couple and you have a million dollars invested (that may sound a lot but it is very little if it has to last for the rest of your life and you live 30 years or more), then for a million dollars you only receive $26,000 a year in interest and inflation makes sure you lose another 2-2.5% in buying power.
This means your million dollars will next year buy only $975,000 worth of goods as everything becomes a little more expensive.
If the couple in this example spends $66,000 a year, their million dollars will reduce to $934,000 in a year in 2017 dollars. After a few years that million dollars will be down to $600,000 and the couple may start to feel increasingly uncomfortable as they see where their assets are heading.
Once their assets go below $600,000, their situation improves as the aged pension comes in and pays more and more of their expenses but overall their wealth is still going down. This is the classic dilemma when you invest in extremely safe, non-volatile investments like cash or term deposits. They are very safe but their lack of income makes certain that your safety net becomes smaller and smaller over time.
There is a simple way to deal with this – invest in a mixture of shares, bonds, cash and term deposits. These will go up and down more strongly but, unlike the term deposits, the direction will not always be down and over time, they almost always perform better than term deposits.
It is the 10-year anniversary of the previous sharemarket peak which was in November 2007. Even though we had the global financial crisis in that time and the sharemarket is still below the November 2007 peak, Australian shares returned between 3 per cent and 4 per cent a year on average (because they pay dividends) and bonds during that time returned an average of 6% a year. Normally it is the other way around with shares performing better than bonds.
In other words, even during the second worst financial crisis in the past 100 years people did ok over time and if you have the above mixture, then your investment experience is far less volatile than if you only own shares.
Therefore term deposits are very safe but they also very steadily decrease your wealth if that is the only way you invest.