Cash returns

I am 55 years old and approaching retirement. I have always held bonds but have recently sold them as I was told that cash deposits presently offer a better return. Do you think that I should purchase a five- or ten-year fixed deposit and start taking an income from this when I need to in retirement?

A The reason that the price of bonds is falling is because interest rates are rising. As short-term interest rates catch up with long-term interest rates, investors are understandably unwilling to purchase medium- to long-term dated bonds.

At the moment in euro, you can expect instant access rates and fixed deposit rates to vary from anywhere between 2.5 per cent and 4.5 per cent. In sterling you can expect interest rates varying from five per cent for savings to around 6 per cent for longer terms. After the 15 per cent withholding tax has been taken off, the expected return would be up to 3.8 per cent for euro and up to five per cent for sterling.

While some cautious investors may find these returns acceptable, what they fail to take into consideration is the rate of inflation which erodes the real return on your deposit. In this example, if the annual inflation rate is two per cent, then the maximum real return is only 1.8 per cent in euro and three per cent in sterling on term deposits.

In addition, on January 1, 2008, we shall be adopting the euro, so any returns on sterling cash deposits are also affected by the exchange rate, so there is an added currency risk to your capital where losses could exceed the interest earned if the rate of exchange works against you.

History has shown that equities outperform property which outperforms bonds which outperforms cash in that order. Statistics from the US show that between 1978 and 2005, local investors had an annualised return of 13.1 per cent on equities, 9.9 per cent on property, 8.7 per cent on bonds and 6.1 per cent on cash.

Diversification is key to investing and you should never put all your eggs in the one basket. Different advisors have different views on how much you should put into cash, bonds, property and shares. One approach is that the percentage of your portfolio that is invested into cash and or safe bonds should be equivalent to your age. This, in your particular circumstance, is 55 per cent with the rest in property and equities.

Cash deposits will give you income to supplement your pension, while property and equities will grow your capital to protect your portfolio from the effects of inflation and also provide you with a rising income in the years to come.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 or e-mail mh@hollingsworth-int.com.

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