By Mark Folpp
02 September 2019
Until recently, the Reserve Bank of Australia (RBA) had kept the official cash rate on hold at 1.5%, with no change at all for almost three years. In June 2019 they commenced a cutting cycle, slicing the official cash rate twice by 25 basis points, taking Australia’s official cash rate to a new all-time low of 1%.
The RBA’s stated aim is to drive unemployment in Australia lower in the hope of igniting stronger wages growth, and with it, a pick-up in the rate of inflation. The minutes from the RBA’s recent meetings point to the prospect of further rate cuts in the near term.
It remains to be seen if the RBA’s interest rate policy will be effective in delivering on this aim. What is certain, though, is that it is now becoming very difficult for conservative investors to earn a reasonable return on their cash and term deposits.
In recent years, low interest rates have been a fact of life in many developed countries. Central Banks in the US and Europe slashed their interest rates to near zero as a policy response to the 2008-2009 Global Financial Crisis. Japan, the world’s third largest economy, has had a zero-interest rate policy in place for the past 20 years.
Until recently, it appeared as though Australia did not face the same pressures to join the zero- interest rate ’club’ but this now seems to have changed.
What does this mean for conservative Australian investors seeking income?
Returns from traditional ’safe’ assets like cash and term deposits have fallen to the point where they are, in many cases, negative in real terms (that is – below the rate of inflation). This is increasingly forcing investors to consider increasing their risk tolerance in pursuit of income. This has resulted in otherwise conservative investors being forced to consider holding more growth assets, such as shares and listed property trusts, in the pursuit of higher levels of income and the potential for capital growth.
Some attractive yields on offer in the market today
Term deposit rates around 2% per annum now compare very unfavourably to a grossed-up annual dividend for the Big 4 banks of 10% (including imputation credits) or listed property stocks yielding around 6% for the same period.
To invest in these types of income producing investments, you need to accept that the price of the investment may move around in line with the market and that these dividends may change in the future, depending on how that company performs financially.
With an understanding of your financial circumstances and your risk tolerance, a skilled financial adviser can help you understand the nature of the increased investment risk you may need to take in order to satisfy your retirement income goals.
With diversification and careful asset allocation, that allows for contingencies, there are sensible ways to increase your tolerance of the additional risk you may now need to take.
A portfolio that is diversified across the core asset classes of shares, property, bonds and cash should, over time, deliver a higher return to investors than what they can expect from a passive term deposit investment.
It appears that very low interest rates may be with us for some time, so now is the time to review your investment strategy. Contact a professional at PKF Wealth to guide you through your best options to achieve your goals.
Disclaimer: always seek professional advice when making financial decisions. The investments outlined are for illustration purposes and are general advice only.