Keep in mind the following information is General Advice and is obviously not personalised for your unique needs, objectives or financial situation. Please get in touch with your advisor before taking any action on the below points so they can advise on the appropriateness of this for you.
The low interest environment we find ourselves in at present has come about from a combination of factors. The Official Cash Rate (OCR – the cash rate), or rather the official interest rate, set and controlled by the Reserve Bank of Australia (RBA) currently sits at 0.10%. This rate influences interest earned by investments like term deposits where the current 12-month term deposit rates are ~0.70% pa. Despite such low bank deposit rates, many investors have not changed their short, medium and long-term earnings expectations.
The RBA has stated that it intends to keep interest rates low for the foreseeable future and for as long as it deems necessary to return to a more stable economy. This may mean the days of earning 5% – 6% pa with little to no risk are a long way off. This article highlights the impact low interest rates have on your investment portfolio.
What Does a Low Interest Rate Environment Mean?
Setting the cash rate is a tool the RBA uses to help control the economy. Although the impact of low interest rates is not an exact science, there are certain patterns to anticipate when investing. Some of the more common themes to expect during times of low interest rates include:
- Stock & property prices tend to rise – as bank deposit rates diminish, investors look to shares and property for more attractive returns and to generate income. The increased demand pushes share prices and property prices higher.
- Bond prices rise – As interest rates fall, the income or yield from bonds generally falls as well. Lower bond yields results in higher bond prices
- Increased domestic spending – low interest rates deter savers, encouraging Australian households to spend their money to stimulate the economy. Additionally the cost of spending via personal loans, business loans and credit cards reduces. This increases the likelihood of business and personal spending.
- Export activity increases – lowered value of the Australian dollar makes national goods cheaper and more sought after internationally; increasing the flow of money into the Australian economy and creating jobs. Imports conversely slip.
Low Risk Assets in a Low Interest Rate Environment
Five years ago it was reasonable to expect a 6% return pa from a Balanced style investment portfolio; one which historically has held 60% in stocks (or other growth assets) and 40% in bonds (or other defensive) investments. In today’s environment, the likelihood of the same portfolio producing a 6% return is much lower as paying higher prices for growth assets means it is harder for them to generate the same return as before and you get paid less on your bonds.
To generate the same 6% return investors must then choose to either have more growth assets and take on more risk (to compensate for the lower amount of income that defensive assets produce), accept a lower return or look for alternatives to traditional investment strategies to manage the risks the low rate environment creates.
In a low interest rate environment, managing investment risk is an integral part of portfolio construction. Risk must be balanced with the potential for lower returns and the potential for inflation to erode your capital. Understanding these risks is the first step in making informed investment decisions that are right for you.
Low Interest Investing and Retirement
For retirees and pre-retirees whose aim is to preserve capital built up over the years and generate income to fund their lifestyle, a defensive portfolio in a low interest environment may mean investment returns do not cover income needs, the impact of inflation, and over the longer term the potential for your money to run out.
Budgeting, planning and implementing investment portfolio strategies are useful to mitigate longevity risk, or the risk of outliving your capital.
As always, the team at Morrows Private Wealth are here to guide you in your investment and wealth management needs. We can advise on strategic investment risk management and can prepare financial modelling outcomes to help plan your investment’s longevity.
If you have any questions about any of the above matters, don’t hesitate to get in touch with your Morrows Private Wealth advisor today.