What is worse than earning negative (real) interest rates on your investments?

Investors are agitated. A lot of them have missed out on the equity rally. Many sold out shares at lower market levels. Fear made them put their money in bank fixed deposits.

Today deposits have matured, money is in savings bank account earning 3.5% nominal and a huge negative real rate of return on their money. What could be worse than this? Come to think of it, there could be many things worse than this.

1. Locking into negative real rates for a long time. Many investors in the desire to ‘improve’ returns would go in for longer maturity fixed income investments. This could be a mistake. Interest rates have to move up sooner or later. Bear with the negative returns for a while. Don’t lock into smaller negative rates for a very long time.

2. Taking foolish credit risk. Anyone in the market for Greek bonds at 14% per annum? (2 year Greek bonds had briefly touched 38% yield in trading). Well you could get 14% but there is apparently a 50% chance that Greece could default on its borrowings. In such a case you could even lose a substantial portion of your principal. In a low interest rate environment debt offerings at somewhat attractive interest rates will seem very seductive. I would be best to avoid the siren song and work on preservation of capital.

3. Buying foolish “alternative” investments. It is precisely when interest rates are low for a long time that ideas like investing in wine, art, commodities, watches etc. start floating around. There is ample time to regret these investments later when markets become somewhat normal.

4. Buying overvalued equity. Just because you missed a bus is no reason to try and board a running bus. It is always better to wait for individual opportunities to arise rather than work with a plan to forcibly deploy cash.

As someone said “Buying something and holding on is by far easier than staying liquid waiting for the right opportunity to come your way”.  

Where will the $ 3.8 trillion go?

Financial Times has an interesting article today. It is about the difficulties being faced by Money Market Mutual Funds. There are approximately $ 3,800 billion worth of funds in this category and the returns are essentially ZERO. The Asset Management Companies are not able to make any significant money managing these funds and neither are the investors. Many are contemplating closing down the funds.

An interesting comment was  “The Fed is trying to force investors out of a low-risk environment” Hence if the money market fund is closed, what option does the investor have? If an investor is keeping money with Citi or Bank of America he / she is anyway exposed to credit risk. Why not start looking at say a commercial paper of GE.

All the investment gurus who recommend holding cash in this environment will also have to specify where to stash all that cash. Mattresses anyone?