July 13, 2022 —
With soaring interest rates and an uncertain future for the markets, it’s hard to know what to do with those dollars still left in your bank account. Should you invest? Save it all? Stuff it in your mattress or covert to Krugerrands?
Dr. Lei Lu is the Bryce Douglas Chair in Finance. He holds a doctorate in finance from McGill University and a master’s degree in management from Tianjin University, China. He taught in the Guanghua School of Management at Peking University (2011-2016) and the School of Finance at Shanghai University of Finance and Economics (2007-2011) before joining the Asper School of Business in 2016.
UM Today asked him for his opinion on the current world economy and financial situation, and for tips on how Canadians can navigate unsettled financial waters.
There are a number of apps for phones these days that seem to make trading very easy for a novice. Are they worth trying?
In recent years, many trading apps (e.g., Interactive Brokers) are available for investors, in particular, retail investors to trade stocks, bonds or options. There are many benefits of trading online for investors. For example, investors do not need to meet a physical broker and therefore they can save management fees. Further, the apps can allow real-time monitoring of prices and trades.
However, there are also limitations to using trading apps and investors face some potential issues. First, when using online trading, you only need to push a button to make a trade. But you might have a tendency to invest too much or too fast, leading to irrational decision. Second, some investors could become addicted to using trading apps just as some people can’t stop scrolling through social media such as Facebook or Twitter. This might make them trade more often. In addition, online trading relies on internet stability and the accuracy of computers, but there could be software or technical issues. All of these situations can lead to negative effects on investors’ trading performance.
Should the average person seek out a financial advisor for investing?
It depends on an investor’s financial situation. If they have high net worth and their tax situation is complicated, it is a good strategy for them to seek out a financial advisor. Otherwise, the service cost of financial advisor will cancel investors’ profits from investment.
Given rising inflation, what are your suggestions for investors right now?
High inflation pushes central banks to increase interest rates, and we have observed that the Bank of Canada has twice increased twice the interest rate by 50 bps each in the past few months. This makes borrowing money more expensive, decreases companies’ revenue, and the expected return on firms’ stocks will be driven down. Investors can reduce their investment in stocks and invest more in safer assets, such as government bonds.
Is it better to invest in bonds or stocks right now?
As I said, investors can reduce their investment in stocks and invest more in safer assets, like government bonds, during a rising inflation period. Regarding corporate bonds, their prices are sensitive to interest rate changes. As interest rate increases, the price of existing corporate bonds declines since the newly issued bonds offer investors higher interest rates. However, this negative effect is relatively weaker for short-maturity bonds. Therefore, one of the best strategies for bondholders is to hold onto short-maturity bonds during high inflation period.
Are there really any “safe” stocks right now?
It is well known that stock investment is not safe since higher returns are accompanied by higher risks. Ex post, we did find some stocks earned higher return and have lower volatility. However, ex ante, it is extremely difficult for average investors to predict which stocks are safe investments based on a small number of data samples. The expected stock returns are affected by many firm characteristics, and size is one of them.
Is cryptocurrency a wise investment at the moment?
Contrary to classical currencies, the supply of cryptocurrency is capped at 21 million, implying that crypto is a deflationary virtual currency. Existing studies also suggest that the return on cryptocurrency is affected by inflation and monetary policy. Therefore, it is a controversial issue whether cryptocurrency can hedge against inflation.
Do you see an end to rising inflation in Canada soon?
The current inflation rate is 7.7 per cent. Historically, it has not been very high except during the period of World Wars I and II, and later in the 1980s (when it was 12.5 per cent). The Bank of Canada’s increase in interest rates should relieve the pressure on inflation. However, this effect also depends on peoples’ expectation about the uncertainty caused by the pandemic. If the interest rate is expected to rise and the economy can recover soon, there is a good chance to see the end of high inflation in few months.