Stay in cash or where to invest it?

saverted

bowlhead99 wrote: »

I would not put 35% of a portfolio into those, no. Some strategic bond funds would have an allocation to them, and various multi-asset or conservatively managed funds would use them or have at least used them in the past. But not your entire non-equity holding.

You have to remember that when you are participating in the bond market only the coupon (how much does it pay per year) is fixed (or inflation linked in this case). The actual principal you get back depends on market movements.

You buy a bond in the market, effectively second-hand, at a price based on what everyone else will pay at that point in time. When you come to sell, you will get a different price based on what everyone else will pay at that time. Will you keep pace with inflation? Not necessarily, no.

Why is that? Well, the buy price already reflected the market's expectations for inflation. If everyone thinks inflation is going to stick at 1.5%, then when it does indeed stick at 1.5% and we know the bond will actually pays out those amounts - the value of the bond is no more valuable than it was when you bought it and people assumed it was going to pay out those amounts anyway.

If people are expecting inflation to be 2% this year and it's only 1.5% then the bond will be paying a lower coupon and a lower redemption payment than everyone thought, so the price will fall.

For example according to BBC today, BoE just halved its expectations for wage growth this year, to 1.5% from a much bigger number. That will feed into everyone's expectations for overall price inflation. So if people were assuming the indexed gilt would reflect 2% inflation for this year they will now be rethinking it and be happy to offload the indexed gilts as compared to regular gilts.

And more generally if a gilt is set up to be paying x% plus inflation and then market interest rates go up to 2x% plus inflation then the capital value of the bond still gets hammered - although perhaps changes in inflation expectation might soften some of the blow.

If inflation goes up more than the market thought, then yes the bond makes money. So over the long term it can give you protection against rising prices. Of course this only in terms of whatever government inflation measure it's linked to, and not your personal inflation rate based on the price of gadgets or bottles of wine or housing or stock market investments that you want to buy in future.

So there are quite a few things to think about

Thanks for this explanation. As you say there is a lot to think about.

I am starting to wonder if I would have been better keeping everything in my equity trackers instead of moving 35% into cash. Being 100% equities has a big downside risk but it looks like there is nothing else that will at least keep value with inflation without its own downside risk. Is the downside risk of bonds at least more limited?

Linton

saverted wrote: »

I am starting to wonder if I would have been better keeping everything in my equity trackers instead of moving 35% into cash.

Yes

saverted wrote: »

Being 100% equities has a big downside risk but it looks like there is nothing else that will at least keep value with inflation without its own downside risk. Is the downside risk of bonds at least more limited?

Your basic assessment is correct - higher returns are only justified by higher risk.

The downside risk is more limited as a bond has guaranteed income, so as long as the bond issuer doesnt go bankrupt the bond will always have a significant value. Share owners come after bond owners in the queue for a bankrupt company's assets so are much less likely to get anything, and shares can drop massively in value without the company going bankrupt.

But bond values are inversely dependent on interest rates, and interest rates cannot go any lower. So a decrease in bond values at some stage is completely predictable. However the slower the rate at which interest rates rise the less the effect on the bond market - you still get your income even though the capital value may fall, on maturity the bond is guaranteed to be redeemed at face value, and new bonds will be issued under the then prevailing interest rate situation.

bowlhead99

Keeping up with inflation over the long term while in the short term being liquid enough to jump into other assets at a moment's notice does require risk.

A bank is not going to guarantee you get your cash back instant access whenever you want *and* pay you an inflation equalling return, because it can't take a risk with the money and make any returns with which to take a profit and cover its costs and afford to pay you back out what you gave them increased for RPI.

At one point, National Savings offered inflation linked savings certificates but they are no longer doing new issues. So you have to use "the market" one way or another. To be honest, if the goal is to avoid a potential 40% loss by not having all your assets in equity trackers that track the market downwards, the question of whether you make an inflation-equalling 1.5-2.5% or only a less impressive 1%, is neither here nor there.

But if you look back up this thread there are plenty of things being discussed that are not risky as equity trackers while still having return potential. None of them are perfect so you wouldn't go and put everything in just one of them.

Yes generally bonds are less risky than equities. Stubbornly keeping everything in an equity tracker just because "hey, other things might go down too" does not sound like a particularly robust solution, it's more like putting your head in the sand. The examples given by Linton and Kidmugsy of funds that were less risky than just buying a bunch of random mainstream equities, were pretty sound.

Glen_Clark

You cannot avoid the risk of a 40% loss by holding cash: http://www.amazon.co.uk/When-Money-Dies-nightmare-Hyper-Inflation/dp/1906964440

kidmugsy

http://www.moneymarketing.co.uk/news-and-analysis/bonds/fca-warns-on-corporate-bond-liquidity-risks/2012741.article

http://abnormalreturns.com/to-bond-etf-or-not/