The personal impact of a low-interest environment

The Reserve Bank’s very recent decision to cut the official cash rate to a 54-year low of 2.25 per cent will no doubt encourage more of us think about what this extended low-interest environment personally means to homebuyers and investors. You may need to seek independent investment advice.

Five short years ago you had major banks offering three-year term deposit rates around 7% in January 2010 according to the RBA statistics. That has been steadily declining over recent years and with the Reserve Bank’s move to cut official rates by 25 basis points last week three-year term deposits are now on offer for around half that. If you are looking for shorter terms then the rate drops further still to around 3.4%.

Investors are not all on the same team when it comes to interest rate changes. Those with a mortgage, considerable personal or business debt will gain significantly from rates being at all-time record lows.

Reactions to low interest rates are varied

Australian term deposit rates raise a need for independent investment advice

Australian term deposit rates

On one side, the long period of low rates has fuelled the strong rise in home prices as homebuyers can borrow more to buy more expensive properties. Yet low rates have given many existing homebuyers the opportunity to increase their monthly repayments above the required minimum to reduce the life of their loans and to potentially save huge amounts in interest. Another benefit of making extra repayments during times of low interest is to gain a buffer to deal with a rate rise sometime in the future.

From an investor’s perspective, a low-interest environment means lower returns from cash and fixed interest investments. Yield investors are now feeling the impact of our slowing economy and the Reserve Bank’s move to stimulate growth.

SMSF trustees will no doubt have been keen students of the Reserve Bank decision not just because it dropped the official cash rate to 2.25% cent but more for what it signalled for the future. Cash rates potentially could go lower and stay down for longer.

The investor cohort that is most directly impacted by rate cuts are retirees, because they typically will not get any offset from lower mortgage payments and are more dependent on the term deposit payments to supplement their household income. Retirees probably are feeling like they are caught in a pincer movement with falling interest rates at a time when market forecasts for returns for local and international shares are subdued.

Independent investment advice can factor in risks

The RBA move is a blunt reminder that investment markets move in cycles and investors need to balance expectations accordingly. Following the RBA rate decision the Australian share market enjoyed 12 days of gains – largely attributed to the rise in high yielding stocks. While the quest for yield is understandable – particularly among retirees – the increased risk along with the likelihood of more volatile markets needs to be carefully factored into any decision.

Wholesale shifts in portfolios away from various market segments – from fixed income to more volatile assets like shares for example – has the potential to undermine the sound, long-term principles of setting a strategic asset allocation to match your personal risk appetite.

Fixed income will continue to perform a critical role as a diversifier to counterbalance the volatility of shares and other growth assets, reducing the variability of returns from a diversified portfolio. Reducing the variability of returns becomes even more critical as investors move from the accumulation phase (savings) to the draw down phase (where investors need to generate passive income from capital to fund living needs)

There is plenty to think about in a low-interest environment, and independent investment advice may be beneficial.

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