Here's how to stay on the right side of increasing wealth gap

Will the Great Virus Crisis (GVC) put the handbrake on your desire to invest in the

sharemarket and your retirement?

Like its tiny cousin, the 2008 Global Financial Crisis (GFC), we all worry that Covid-19 is going to cause years of sleepless nights.

What might surprise is that money poured into the global economy by governments in every country, could eventually see shares and property prices rise further.

Failing to keep investing through these tough times might cause you to be on the wrong side of an ever-increasing wealth gap. That gap is driven by a little understood tool – quantitative easing (QE).

This is a changed world for investors, but there are two lessons for the future; liquidity and asset price inflation.

1. KiwiSaver isn’t liquid

As we’ve seen, the only lockdown tighter than level 4 is your KiwiSaver fund.

Structurally it has full daily liquidity, but the ropes of regulation stop that being used.

KiwiSaver is suitable for the free annual gift and collection of employer contributions, but beyond that, it may be time to divert. All managers sell exactly the same type of fund with full access, plus the benefit of diversification.

2. Quantitative easing could cause another asset price boom.

We learned from other countries in the 2008 GFC that quantitative easing (injecting money into the economy) didn’t cause inflation in the form of higher consumer or producer prices. But share prices and property prices rose dramatically (asset price inflation) and this wasn’t acknowledged or complained about as being inflationary.

Traditional definitions aren’t wide enough and central banks around the world are not tasked with controlling it.

While government spending and wage subsidies shore up consumers in a crisis, quantitative easing shores up the markets and stops corporate collapse and free-falling share prices. It’s part of stopping a deflationary spiral in jobs and prices.

How does QE work?

Colloquially it’s known as money printing (but it’s not quite). Banks, pension funds, insurers and companies have previously invested in government deposits that pay a fixed rate of interest (bonds).

Quantitative easing just reverses their investment. The Reserve Bank buys the bond certificates back and returns the cash to these firms. They create new electronic money to do this and become the new owner of government debt.

The idea is the banks have more money for lending and other firms are flush with cash for new investments, as it’s not tied up in bonds. These corporates have to invest in something else. If it heads into the sharemarket and property, their demand pushes up prices. Ta-da, QE-driven asset price inflation 101.

QE has slightly less creative accounting than printing money as it’s backed by bonds that already existed. It seems a subtle difference to most of us, but failure to understand will see the Governor of the Reserve Bank gnash his teeth.

It comes with the intention of lowering interest rates and increasing the money supply with new lending and flow of investments. So it has a similar goal and effect.

With all major central banks carrying out QE and increasing their balance sheets by inventing new electronic money, no one currency suffers a mass devaluation.

It takes more of any currency to buy inflated assets, so dollars, euro and yen are all worth less in a practical sense. Inflation and deflation come in different disguises these days.

As morally reprehensible as it all seems, viral-QE could cause the wealth gap to widen again. The divide is between those with assets and those without.

It may take a while to kick-in, but it’s difficult to see how this tsunami of money will leave asset prices untouched in the next 10 to 15 years. Governments no longer allow failure. The risk beyond Covid and QE is that of asset price bubbles.

Saving 10 times your salary

While we are going through one of the strangest periods in history, the pressure to save for retirement doesn’t change.

You need roughly ten times your final salary as a retirement pot. I do harp on about this rule of thumb and it gets plenty of noisy hisses from commentators who think reality scares people.

If a senior person in your profession earns $200,000 a year, you need to aim for a $2 million nest egg. If it’s $70,000 aim for a $700,000 portfolio. This allows us to retire on half our final salary. It means saving 15 per cent of your wages from age 25 or 23 per cent from age 35.

Why am I raising these numbers at a time of incredible economic pain?

If quantitative easing leads to more asset price inflation in the years to come, you don’t want to be on the wrong side of the wealth gap.

With nearly the whole working population in KiwiSaver, any inflationary uplift will mean most people rise with the tide. Those who value flexibility will keep their savings liquid by choosing funds outside the work-place scheme, for additional savings.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.