On Tuesday the RBA reduced the cash rate to 2%, down from 7.25% in 2008. While most of the media attention has focused on how great this is for those with mortgages, little attention is given to conservative investors who are relying on income generated from cash and term deposits. This places these people in a tricky situation – do they hang on and remain in cash or do they bite the bullet and seek higher returns in the stock market? This tough decision is compounded further as it is asking them to risk their already reduced capital in an asset class that they have deliberately avoided, possibly since the financial crisis in 2008. In reality they are being forced to take more risk with less to fall back on if things go pear-shaped again. This is a problem that many retirees have been facing for some time around the world. Believe it or not, Australia still has one of the highest cash rates when compared with other western economies, such as New Zealand (3.50%), Canada (0.75%), Eurozone (0.05%), UK (0.50%) and USA (0.25%). This in stark contrast to countries like Sweden or Switzerland, who have negative interest rates – yes, negative – at -0.25 and -1.25% respectively.
A major concern for the RBA in setting interest rates is balancing out the need to stimulate a shrinking economy, whilst not encouraging more speculation on an over-valued housing market, particularly in Sydney. This is an unusual position to be in, as the economic needs vary from city to city, state to state. The general consensus from economists is that rates will remain low for some time.
So what is the correct course of action for a conservative investor? Unfortunately there is no “one size fits all” solution. The answer still depends on the individual investor’s appetite for risk, their time frame for investing and whether they are drawing down on their capital. Once these factors have been taken into account, only then can we suggest a portfolio that will increase the probability of delivering what they are setting out to achieve. Usually this will include a well-diversified spread of investments to manage the need for capital protection and regular income.
When interest rates rise or fall there are always winners and losers. Just like grain prices or variability of seasons, nothing much stays the same and it’s being able to ride out these changes and, even take advantage of them, that provides the opportunity to prosper. Whatever happens, there are always consequences.
Ever since the late 1980’s when interest rates were in the high teens (some of us remember those horrid times), rates have gradually fallen to reach the current official cash rate of 2.5%. Our Reserve Bank Governor, Glenn Stevens, alluded last week to the possibility of reducing rates further in a bid to lower the value of our currency.
The most obvious consequences of lower interest rates are:
- Savers get punished
- Borrowers generally benefit
- We attract less foreign capital
- Exporters benefit because of lower exchange rates
- Importers are less competitive because of lower exchange rates
- Investors are subtly ‘forced’ to invest in higher risk assets
- It’s likely that market excesses and financial bubbles are created because of cheap money
I have read a number of articles recently that all point to most countries looking at ways to make their exports more attractive by lowering their currency exchange rates. We are in global economy where we are all now so interdependent on each other. So, if a country forces their interest rates and/or currency down, this changes the game for everyone.
A good example of such consequences is Holden and Toyota who are planning to cease manufacturing here. They are struggling to compete. I read recently that an Australian made Toyota Camry is around $3,600 more expensive to manufacture than in other countries! One of my concerns is the complacency and attitude to debt – especially with those who haven’t experienced the impact of high interest rates.
Not only is this a major problem with people in general, but local, state and Federal Governments are currently seeking approval to raise debt limits. This is a sad state of affairs. Personally I feel that we have experienced at least a generation of the best of economic times and sadly our overall debt has increased because money is cheap.
As I mentioned in the first paragraph, nothing stays the same and there are always consequences. We are definitely heading into new economic and social territory. Being prepared for change and how you can benefit is the essence of what planning is all about.
We’ll be in Wudinna in the 3rd week of December 2013 and be pleased to meet you.