The former Treasurer Peter Costello AC, who is now Chairman of the Australian Future Fund, recently sent a timely warning to investors about risky investments.
His point was that record low interest rates may lead mum and dad investors into seeking higher rates with sub-prime institutions.
One way to look at this is to see each institution as a person to whom you may loan money. If you make a loan to a good friend, there is a high probability it will be returned. If you lent money to a complete stranger you met on a corner who offers you a 20% return, you cannot be as confident that you will ever see your savings again.
In many cases, these higher returns are sold as “safe”, “secure”, “guaranteed” or “fixed return”, leading an unaware investor to believe they are investing in a security with a risk profile akin to that of an Australian Government Bond.
We are already seeing these offerings advertised in the newspapers. A 5% or 6% return can seem very attractive, but some or all of the invested capital could be at severe risk in the event of market turbulence.
Our strong belief is that you avoid the hidden or unknown risk that is implied in these investments. Accept the miserable 1% returns on the cash component of your portfolio and then take appropriate risk on the shares and property components of the portfolio. At least that is a known risk.
PS And we are by no means accusing the big banks of being good friends! Or advising to lend to friends!