Way forward in a low interest rate world

The most common question retirees and pre-retirees are asking right now relates to interest rates and how to generate income from any cash deposits. Personal finance guru Noel Whittaker offers the following guidance.

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What is going to happen in a world where interest rates look like staying low for years to come?

There are no easy answers, but I have long believed success requires you to follow some basic principles. A favourite of mine, as we face such uncertain times ahead, is that if you take care of the things you can control, you won’t need to worry too much about the things you can’t control.

The Reserve Bank dropped interest rates even further in early November, so how to find the best bank interest rates and how to best exist in a low interest rate environment.

To find the best rate, I suggest you search online using websites such as Finder, Canstar and RateCity. But keep in mind that rates change continually in the light of the banks’ cash position on the day. Furthermore, many so-called honeymoon rates may be good for six months, and then revert to the bank’s normal rate.

There may also be special conditions. Right now, my wife has an at-call account with St George Bank that pays a face rate of 0.20 per cent but which moves up to 0.70 per cent provided she deposits at least $50 each month.

But the bigger picture here is the role of cash in your portfolio. If you are extremely nervous, and have total financial assets of say $200,000, a difference of 0.5 per cent is only worth $1000 a year to you. That’s not much in the scheme of things. And changing banks continually to grab an extra 0.5 per cent is a mug’s game – you will pay more than you save by incurring extra fees and possibly a loss of interest while funds are being cleared.

If the sum is bigger, it’s not prudent to keep your whole portfolio in cash. Let’s face it – cash is the most expensive asset class you can own as it’s selling at 100 times earnings.

The obvious solution is to seek financial advice about a balanced portfolio, or simply do it yourself via an index fund such as Vanguard Australian Shares Index that currently has a yield of around 4.5 per cent. The cream on the cake is that the yield is mostly franked, so if you are retired with a tax-free income, you will get all the franking credits back. This would take an effective yield to close to more than 6 per cent.

I appreciate that shares are volatile, but by definition an index cannot go broke, and the index fund should keep on paying the dividends irrespective of the normal ups and downs of the share price.

And the great thing about shares is that you don’t need to outlay a massive sum. Let’s say you were rather risk averse, and your financial assets were $300,000 all in cash. You could simply leave $250,000 in cash, and put your toe in the water by investing $50,000 in an index fund. That huge cash buffer would give you plenty of time to ride out any falls in the stock market, and the investment in the index fund would give you great experience with shares.

Of course, if you’re on an Age Pension and are assets tested, every $10,000 you spend returns the equivalent of 7.8 per cent per annum via a reduction in assessable assets. So, instead of chasing an extra 0.05 per cent on your $200,000 cash portfolio, you could simply spend $15,000 on a trip, or home renovation, and get an immediate increase in your pension of $1170 a year. That’s much more fun than chasing a few more basis points on your term deposit.

Have you changed your income strategy given bank interest rates have bottomed out? Have you tried your hand at index funds or on the stock market? What advice do you have for others?

Noel Whittaker is the author of the recently released book Retirement Made Simple and several other books on personal finance. You can learn more at noelwhittaker.com.au

This is an edited version of a blog that first appeared here.

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Related articles:
https://www.yourlifechoices.com.au/finance/banking-and-investment/noel-whittaker-on-riding-out-the-storm
https://www.yourlifechoices.com.au/finance/banking-and-investment/the-problem-with-honeymoon-rates
https://www.yourlifechoices.com.au/finance/banking-and-investment/where-to-invest-for-the-grandkids

Written by Noel Whittaker

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