Are bank deposits risk-free in the long term?

[Gordon Gekko]

Where did I say that?

Based on your comments you are mixing and matching different topics to support your point but to a person with a detailed understanding of risk management it is clear there are gaps in your logic. From what I can see you think Irish Banks defaulting are more likely over the long term versus any Corporate in a well diversified Equity Portfolio. Therefore holding cash in a bank is riskier than putting it in the stock market.

So for my understanding you believe that if I have $100 to invest for 20 years, with the goal of having $100 (plus nominal bank interest) in 20 years time (zero risk appetite), the less risky option is to invest Equities rather than hold it as cash?

Firstly, when I use the term “risk”, I am not referring to volatility; I believe that over 20+ years, keeping my money in cash is more risky than investing in a diversified portfolio of global equities. With the former, my view is that I’m almost guaranteed to lose money in real terms. With the latter, I believe that I’m almost guaranteed to make money in real terms.

 

[RedOnion]

With the former, my view is that I’m almost guaranteed to lose money in real terms

And the markets have that exact expectation.
As a barometer to what a real risk free return would look like, there is a German inflation linked bond maturing in April 2046. 26 years from now (taking OP to 67). Based on today's price, it's currently yielding -1.04%. I think it's close enough to being risk free to use as an example.
So for every 134.00 Euro invested today which gets you 100.00 of bond, you will receive 0.10 interest annually, plus inflation based on 100.00, plus your original 100 Euro back in 26 years. In other words, investing 4m will give you back roughly 3m in today's value in 26 years time.

 

[Brendan Burgess]

From what I can see you think Irish Banks defaulting are more likely over the long term versus any Corporate in a well diversified Equity Portfolio.

No. I think that if you have a diversified portfolio of equities, some of them will default. But the 100% loss on these will be more than compensated for by the 100%+ rise in some of the others.

Red's figures are very interesting. If you invest in a German bond, you will lose 25% of your money over 26 years.

There will be no volatility if you keep it to maturity. Therefore most people would think it's not risky. Madness.

Brendan

 

[Andrew365]

No. I think that if you have a diversified portfolio of equities, some of them will default. But the 100% loss on these will be more than compensated for by the 100%+ rise in some of the others.

Red's figures are very interesting. If you invest in a German bond, you will lose 25% of your money over 26 years.

There will be no volatility if you keep it to maturity. Therefore most people would think it's not risky. Madness.

Brendan

Honestly, this is blowing my mind. Please let me know the shares your think are going to rise 100% over the next 26 years.

Red's numbers are correct, but my point was cash is less risky, than an equity portfolio. You are thinking about Risk the wrong way, maybe you should take it up with the European Central Bank or Federal Reserve as neither of them stress cash in their annual stress tests. I have 15 years experience in managing risk, and have studied it.

What I can see here is that your view on risk is what your ending point will be which is fair enough for a retail perspective. But what is astonishing me is that you keep mixing concepts to support your point, the comment above regarding 100% returns, is just astonishing.

I am still interested to hear what your supporting material is for the comments made regarding the Irish Banks defaulting?

 

[RedOnion]

Red's figures are very interesting. If you invest in a German bond, you will lose 25% of your money over 26 years.

There will be no volatility if you keep it to maturity. Therefore most people would think it's not risky. Madness.

Brendan, with respect you seem to have a lack of knowledge of risk theory.

Let me explain.

That's a risk free rate. You're guaranteed to lose 25% of your investment. With equities you might lose money, but there's no guarantee. Why take the risk?

 

[Brendan Burgess]

the comment above regarding 100% returns, is just astonishing.

Hi Andrew

Are you saying that in a diversified portfolio of shares, some will not return over 100% over 26 years? Just to be clear that is a compound annual growth rate of 2.7%.

I don't know why you would be astonished by that.

Brendan

 

[Brendan Burgess]

maybe you should take it up with the European Central Bank or Federal Reserve as neither of them stress cash in their annual stress tests

So they never stress tested cash in Italian, Greek, Irish or Spanish banks?

Seems like that was a mistake. But maybe they are forced to make that mistake as to do otherwise would probably cause a run on the banks.

Back in 2006, did your organisation have deposits in Anglo and the Irish Nationwide?

Brendan

 

[Andrew365]

Hi Andrew

Are you saying that in a diversified portfolio of shares, some will not return over 100% over 26 years? Just to be clear that is a compound annual growth rate of 2.7%.

I don't know why you would be astonished by that.

Brendan

I misread your point, but this would again require you to be able to time the market, which I don't believe you can do.

So they never stress tested cash in Italian, Greek, Irish or Spanish banks?

Seems like that was a mistake. But maybe they are forced to make that mistake as to do otherwise would probably cause a run on the banks.

Back in 2006, did your organisation have deposits in Anglo and the Irish Nationwide?

Brendan

Again you are mixing concepts. The individual banks are stress tested, but the cash product is not stressed. In the financial Crisis did the Euro get affected? No, it did not, what was affected was the Bank that held your Euros. This is the point I am trying to make, cash is not risky, but the institution you hold it in does have risk. When I say cash I referring to the Euro as a safe currency.

If you believe that there is going to be an issue that the value of the Euro significantly decreases then by default your Equity portfolio is going to see a significant downturn.

Is this clear yet?

I would be grateful with your experience why it is a mistake for Central Banks not to stress Cash?

 

[Brendan Burgess]

this would again require you to be able to time the market, which I don't believe you can do.

Hi Andrew

No, it would not and I can't time the market.

If I had €4m now, I would invest it in the market.

If I get €4m in 6 months, I will invest it in the market.

Brendan

 

[Brendan Burgess]

This is the point I am trying to make, cash is not risky, but the institution you hold it in does have risk. When I say cash I referring to the Euro as a safe currency.

So where would you suggest that the OP put his €4m? Can he put it in euro but not be subject to bank risk?

Brendan

 

[Brendan Burgess]

If you believe that there is going to be an issue that the value of the Euro significantly decreases then by default your Equity portfolio is going to see a significant downturn.

A diversified portfolio will have income streams in all the major currencies.

They will all be affected by inflation, but the return on equity should exceed that inflation over the longer term.

Brendan

 

[Brendan Burgess]

why it is a mistake for Central Banks not to stress Cash?

It was certainly a mistake not to "stress" cash deposits in the Irish Nationwide and Anglo. There was a significant risk of default. However, if the Central Bank did that, they would have precipitated a default.

By "stress" here, I mean that they should have required AIB to have higher reserves against their deposits in Anglo.

Brendan

 

[Sunny]

I misread your point, but this would again require you to be able to time the market, which I don't believe you can do.



Again you are mixing concepts. The individual banks are stress tested, but the cash product is not stressed. In the financial Crisis did the Euro get affected? No, it did not, what was affected was the Bank that held your Euros. This is the point I am trying to make, cash is not risky, but the institution you hold it in does have risk. When I say cash I referring to the Euro as a safe currency.

If you believe that there is going to be an issue that the value of the Euro significantly decreases then by default your Equity portfolio is going to see a significant downturn.

Is this clear yet?

I would be grateful with your experience why it is a mistake for Central Banks not to stress Cash?

I don't really get your point about stress tests. Banks don't want to be long cash. It's a drag on profitability so they manage it. No bank is sitting on hundreds of millions of euro sitting in their vault or own bank accounts because they see cash as 'safe asset' and part of their investment portfolio and strategy. If the cash isn't working for them, they are losing money so will only hold what they have to meet liquidity and regulatory requirements. Banks don't choose cash as an Investment option.

 

[Andrew365]

I don't really get your point about stress tests. Banks don't want to be long cash. It's a drag on profitability so they manage it. No bank is sitting on hundreds of millions of euro sitting in their vault or own bank accounts because they see cash as 'safe asset' and part of their investment portfolio and strategy. If the cash isn't working for them, they are losing money so will only hold what they have to meet liquidity and regulatory requirements. Banks don't choose cash as an Investment option.

Sunny,

I am not making the point that Banks invest in cash. Brendans point was that as an investor holding cash is riskier than a diversified equity portfolio. What I was trying to explain is that Cash is not risky but the institution you hold the cash in has risk of default. The use of stress test is to support that as Central Banks do not stress Test cash as an asset class.

I agree with your points banks only hold the cash needed to meet capital requirements.

 

[Andrew365]

It was certainly a mistake not to "stress" cash deposits in the Irish Nationwide and Anglo. There was a significant risk of default. However, if the Central Bank did that, they would have precipitated a default.

By "stress" here, I mean that they should have required AIB to have higher reserves against their deposits in Anglo.

Brendan

How do you stress a cash deposit? You don't you stress the Bank, stress the leverage ration, include additional capital buffers. It is worth baring in mind here that we are now in 2020 and not 2008, the capital requirements, and stress testing regimes have been completely overhauled. If 2008 happened today, it would not have the same impact on Banks as it did back in 2008. That is why I have been challenging your comments around the credit worthiness of Irish Banks. To the outside eye Banks are unchanged and still the bad guys, but there has been significant positive regulation over the last 10 years.

 

[Andrew365]

It was certainly a mistake not to "stress" cash deposits in the Irish Nationwide and Anglo. There was a significant risk of default. However, if the Central Bank did that, they would have precipitated a default.

By "stress" here, I mean that they should have required AIB to have higher reserves against their deposits in Anglo.

Brendan

The below is the indication of a well capitalized institution that you should not be concerned with depositing money with.


The transitional CET1 ratio increased to 21.1% (11 billion) at 31 December 2018 from 20.8% at 31 December 2017, and is significantly in excess of the minimum capital requirement.

At 31 December 2018, the Group’s CET1 requirement of 9.725%, comprised of a Pillar 1 requirement of 4.5%, Pillar 2 requirement (“P2R”) of 3.15%, a Capital Conservation Buffer (“CCB”) of 1.875% and a 1% UK Countercyclical Capital Buffer (“CCyB”) requirement that equated to a Group requirement of 0.2%.

https://aib.ie/content/dam/aib/investorrelations/docs/se-announcements/2018/Pillar-3-2018.pdf

 

[Brendan Burgess]

Hi Andrew

There is no doubt that Irish banks are safer today than they were in 2008.

That does not mean that they are risk-free.

If you don't take my word for it, would you take S&P's?

 

[Andrew365]

Hi Andrew

There is no doubt that Irish banks are safer today than they were in 2008.

That does not mean that they are risk-free.

If you don't take my word for it, would you take S&P's?

View attachment 4198

View attachment 4199

Brendan, again you are twisting my words. I have never said that the Banks are risk free.

I am going to write up a post at the weekend to describe the difference between risk and rate of return which is what you have been confusing as risk.

 

[Duke of Marmalade]

Ahhh! Let's try putting a few numbers on this.
5 year horizon:
Worst 10% for cash (in real terms) €3.9m
Best 10% for cash €4.0m
Worst 10% for diversified equity portfolio €2m
Best 10% for equity €8m
40 year horizon:
Worst 10% for cash €3m
Best 10% for cash €4.5m
Worst 10% for equities €4.5m
Best 10% for equities €25m.

So I hope I have reflected both camps' views here. The short term risk of equities are greater but the long term risks of cash are greater. But we still can't tell which is best for OP. We need to know his "utility curve" or as it is sometimes called his risk appetite. It is possible that the prospects of seeing half your money blown in 5 years are so horrendous that it overrides all else in which case you don't touch equities notwithstanding the better long term prospects.

 

[Brendan Burgess]

Hi Andrew

I look forward to your longer piece on this.

I certainly do not set out to twist your words, but I assumed from everything you have been saying and from your initial post, that you consider deposits in banks to be risk-free.

My advice is to invest in your pension, buy whatever state investments are available and put the rest in the bank

There is zero need to take on the risk of the stock market.

So let's be clear. Do you agree that bank deposits are not risk-free?