So interest rates are low again (OK, so the official cash rate of 2.00% has never been this low – but you only have to go back to 2009 to see a bargain basement rate of 3.00%).What does that mean for you and what do you do about it? Well, that depends on which side of the ledger you are looking at it from. Where do you sit?
- Are you concerned for your financial position when anything falls?
- Have you borrowed to invest?
- Are you are an investor who wants or needs a return?
If you are looking at the level of interest rates as a general indicator of how the economy is travelling, you could be forgiven for being worried. This is because the interest rate setting (or monetary policy) is the main tool in the Federal Reserve’s arsenal to influence the pace of economic growth. Low interest rates are designed to stimulate the economy, so to drop to the lowest cash rate we have seen means we need a lot of stimulating.
I am reasonably comfortable that the strategy is working. We have not seen large scale unemployment (apart from that associated with the end of the resource sector investment boom), we have not seen large scale company profit warnings and inflation remains in check (fuel price rises likely to bump the number for last quarter).
The risk is, of course, further slowdown to growth. Monetary policy is a fairly blunt instrument and there is debate whether further rate drops will have the desired impact. The other problem is that low interest rates can fuel asset price bubbles – see Sydney Property prices.
Have YOU borrowed funds?
Happy days! The policy settings are designed to give you more spare cash to spend after making your loan repayments, or to make it more attractive to go to the bank to borrow more. According to the Treasurer, “now is the time to borrow to invest.”
That certainly doesn’t mean that all the rules of prudent investing are out the window. Whether negative gearing faces the chop or not, borrowing to invest requires a reasonable certainty that the asset will grow in value over time. Buying an over-priced asset in the midst of a price spike does not sound like a sound wealth accumulation strategy to me, cheap interest rates or not. Choose your asset class and assets well.
Are YOU an Investor?
Are you an investor -- especially those with a large part or all of their nest egg in cash and fixed term deposits – a low interest rate environment can be challenging. Hunting for the best rate can lead to a marginal improvement, but if you are reliant on the interest to meet your cost of living, it is likely that inflation is making your nest egg lose “real” value. The position is worse if you are paying tax on the interest.
So for those investors, it may be time to consider “withdrawing from the bank and buying part of the bank” – invest a component of their portfolio in shares. Current dividend payouts by the big four banks are handsome and come with tax credits.
Yes, shares and property can be volatile but a well-diversified portfolio is designed to allow you take advantage of assets that are doing well, even if some aren’t. Cash itself has a cycle (in March 2008 the official cash rate was 7.25%, by 8 Apr 2009 it was down to 3.00%, back up to 4.75% by November 2010 and now eased again to 2.00%) so not having all your eggs in one basket can smooth your overall returns.
So, our financial advice and tips for a low interest environment, from your side of the ledger:
- Low interest rates provide you with more bang for your buck when paying off your bad debts. So ensure debt reduction is part of an overall plan.
- Fixing your interest rates can allow you to lock in lower rates for longer although, can add some inflexibility in terms of early repayment.
- Borrowing to invest can bring tax benefits and can magnify your gains. On the flip side, the tax benefits can be removed and losses are magnified as well. It always comes back to the quality of the asset, one not bought at any price…choose well and get advice.
- Borrowing money for depreciating assets (like cars and holidays) is hardly ever a wealth accumulation strategy.
- Be prepared to shop around for the best cash and term deposit rates, but make sure you fully understand what it is you are investing in. Some Investments are packaged to sound simple and like a term deposit but the asset backing can be more risky and complex.
- Be clear on your goals and investment time frame. This will help you to re-consider your tolerance for risk and whether you can still sleep at night if you invested a part of your portfolio in shares or property
- Diversify your portfolio to reduce risk and smooth returns.
- Structure the ownership of your assets (perhaps using trusts, the lowest income earner, super and pension environment) to minimise the impact of tax on your earnings.