Cash v Equities
Hi Damacles
“The subject is about SSIAs. These products have an absolute term of 60 months – nothing more and nothing less.”
I disagree. The tax treatment will change after 60 months, but that does not affect the attractiveness or otherwise of the underlying investments. In particular it would be absolutely no reason for the investor to realise his investment after 60 months if his investment objectives actually suggested a term of, say, 120 months was appropriate. Nor is it a reason for reviewing allocation as between asset classes after 60 months – the tax treatment will change in the same way for all asset classes.
I would concede that, if the investor has invested in an SSIA solely and exclusively to obtain the tax advantage and he has no other interest or objective, 60 months is the natural term of his investment. He should, I think, have been in cash from the outset, so the issue of switching to cash now should not arise for him.
“I have no recollection of saying, nor implying, that the return on cash over the next 3 or 4 years will “exceed” the return on equities. It may do, it may not. What I certainly feel is that the return on a Deposit Based SSIA will exceed that of an Equity Based SSIA over it’s remaining term.”
Point taken. I think what you’re saying here – and please correct me if I am wrong – is this. The expected return on a cash SSIA is, basically, the same as the expected return on any cash fund, which is expected wholesale interest rates less a very modest amount in respect of charges. The expected return on an equity SSIA is same as the expected return on any equity fund, which is the expected market return less a somewhat larger amount in respect of charges. Thus your prediction that the cash SSIA will outperform is not a prediction that the expected market returns for equities will exceed the expected market returns for cash, but that the expected market return for equities, reduced by charges, will exceed the expected market return for cash reduced by (lower) charges.
How does this affect the figures I quoted earlier?
Well, if we assume a total expense ratio of 2% p.a. (which I think is generous) then the fall in our equity unit value over the last twelve months was not 18.1%, but 20.1%. In order to recover these losses over the remaining four years, we need to achieve an annual increase in unit prices of 0.75% which, allowing for the expenses, means a market return on equities of 2.75%. Of course, if we can find an equity fund with an expense ratio of less than 2% - and I think we can – this figure improves.
If the obective is not to recover our losses over the next four years, but simply to beat cash, (and I think this should be our objective) we need to make an assumption about the charges in a cash fund. Let’s assume that the charge is 0.25% p.a. In order for investment in an equity SSIA to beat investment in a cash SSIA over the next four years, market returns on equities have to beat market returns on cash by (2% - 0.25%) which is 1.75%. Again, with an equity fund with an expense ratio of less than 2%, this figure improves.
“I am not sure if, in your example, you are indicating that €1,105 is the net surrender value of the units àfter one year’s contribution (incl. Of Gov. Bonus) amounting to €1,500. If that is the case then I would state the investment to be at a ‘loss’ of €395 or ‘down’ by 26.33%.”
No. I am assuming a contribution of €100 per month, or €1,200 per year, inclusive of the government contribution.
“I don’t understand why you bring up the “ ISEQ total return index” and I fail to see how it adds to your argument.”
Because I think it’s the appropriate index. Do you disagree? Why?
“For some reason you have chosen SSIA products effected in the past year.”
Well, I have to pick some period.
What if we assume that the SSIA started 21 months ago, in May 2001, and therefore has 39 months to run? I’ll spare you the workings, but, in that scenario, to recover our losses we need to achieve a rise in unit prices over the remaining 39 months of 2.47% p.a., implying a market return of 4.47% p.a. (or less, if we can find a fund with an expense ratio of less than 2% p.a.)
The main flaw in my model is that it assumes a steady decline in the index over the period to date, whereas this was not, in fact, the case. The only way to correct for this is to do a much, much more detailed model which, quite frankly, I haven’t the patience for. The purpose of the model is simply to show that recovering losses incurred to date does not necessarily require stellar performance over the balance of the period. As it happens, I don’t think this is a terribly important point, which is why I’m not prepared to spend a lot of time refining the model. The object of an investor should not be to recover the losses he has incurred to date, but to maximise his return over the balance of his investment period. This simply requires him to form a view as to expected returns for cash and for equities over his timescale, adjust for charges and make his asset allocation decision accordingly. My model, however refined, will not help him to do that.
“My view on SSIAs is that the certainty of the return on the Deposit Product wins hands down over the “ifs”, “buts” and “maybes” of a (to date) poorly performing Equity Product.”
Fair enough. But you’re expressing a preference here for stability of returns over volatility, which is not the same thing as expressing a preference for higher returns over lower, and which, obviously, not every investor will share.
Edited by ClubMan to fix ezCode formatting.