| Normally when people hear 'risky investments' their | | | | and their interests, even when compounded. In other |
| attention is immediately switched to stock market | | | | words, deposits are prone to inflation risk. |
| securities such as bonds and especially shares. Bank | | | | Indeed, shares in the long-term have provided |
| and building society deposits never come to mind, | | | | returns that are proportionately higher than inflation |
| because they are considered very safe. This attitude | | | | rates, and hence can stomach inflation better than |
| towards deposits manifests because only one type | | | | bank and building society deposits. |
| of risk called capital risk is being considered. Inflation | | | | Income risk is the probability that interest or |
| and income risks which equally affect deposits are | | | | dividends will fall. Bank and building society interest |
| overlooked. An exposition of inflation and income | | | | rates depend on the economy's short term interest |
| risks will show that bank and building society deposits | | | | rate. Some people's main reason for investing in |
| are not as risk-free as they are thought to be. | | | | deposits or stock market securities is to receive |
| Capital risk is the probability that the price or value of | | | | regular income payments. When the economy's short |
| an asset will fall due to market fluctuations. The | | | | term interest rate falls, bank and building society |
| notion held by many people about deposits is right | | | | interest rates tend to fall as well, and can be a blow |
| when only capital risk is considered. This is because | | | | to income-seeking investors. Deposits are thus |
| uncertainty in the money market does not affect the | | | | subject to income risk, and so are bonds. Annuities |
| value of bank and building society deposits per se; it | | | | are also exposed to income risk, due to variations in |
| is the interest rate that suffers. Conversely stock | | | | long-term interest rates. There is uncertainty |
| market securities such bonds and shares are very | | | | regarding how much dividends are paid by a |
| susceptible to changes in value due to fluctuations in | | | | company; it is the directors who decide, and |
| the market. | | | | sometimes for growth purposes, can decide to pay |
| Inflation risk is the probability of an asset losing its | | | | nothing. Shares, in spite of this uncertainty, have |
| purchasing power. It does rob money of its ability to | | | | proven to provide much higher returns than deposits |
| buy the same 'basket' of goods as it could previously | | | | and bonds alike in the long-term. In the long-run, the |
| do. Let's say you deposit your money in the bank or | | | | good times offset the bad ones; they can withstand |
| building society in year 1 intent on withdrawing it plus | | | | income risk a lot better. |
| accumulated interest in year 3, to buy a car at a | | | | The hard truth is that bank and building society |
| specific price. Take it inflation then was 2.5%. At the | | | | deposits are not as risk-free as they are usually |
| time of withdrawal, if inflation shoots up to 5%, you | | | | thought to be. They are prone to inflation and |
| will receive your principal and the amassed interest as | | | | income risks just like bonds and shares. To add to |
| promised by the bank, but you cannot buy the car | | | | the surprise, although investments in shares have high |
| as envisaged, because the price of the car would | | | | capital risk, they are relatively safer in terms of |
| have shot up, all things being equal, thanks to inflation. | | | | inflation and income risks. |
| Inflation erodes the purchasing power of deposits | | | | |