Retirees face dilemma as low interest rates rob them of income from savings.
Once again this month, the central bank has left its interest rate at a historic low of 1.5 per cent, denying older Australians the prospect of growing returns from their cash savings.
The Reserve Bank of Australia (RBA) board acknowledged that most economic signs were positive, here and abroad, but not heated enough for it to feel the need to use the lever of interest rates to cool things down yet.
At 2 per cent, inflation is still at the lower end of the ideal target, although it is expected to move up next year and in 2020. But don’t expect the RBA to jack up the cash rate in response to a mild pick-up in inflation.
The bank has not moved on rates in more than two years and pundits think any increase is unlikely before the middle of next year.
Why? Because it is still concerned that household spending is constrained and it wants to avoid putting more pressure on working Australians with a mortgage, lest consumption falls further.
Unfortunately, this leaves a large group of other Australians – retirees – stuck in the middle. They, too, are less likely to go a’spending if the returns they get from cash investments is negligible, thanks to weak interest coupled with rising living costs and the likelihood of living longer.
Independent economist Saul Eslake told YourLifeChoices that the continuing subdued interest rates are presenting a real dilemma for retirees.
“All else being equal, the RBA holding the cash rate at its present level of 1.5 per cent per annum for an extended period makes life tough for retirees who keep most of their savings in term deposits, or other products whose return is closely linked to the cash rate,” Mr Eslake said.
“Three-year term deposits, for example, have been paying 2.45 per cent or thereabouts over the past year – after tax … you're not even keeping pace with inflation at that rate.
“Up until recently, most retirees would have been advised to park at least some of their savings in shares carrying a high and fully franked dividend, as do for example the banks, Telstra or utilities. But more recently such investments, though still paying good franked dividends, have carried a risk of capital loss.
“Of course if you're not planning on leaving a bequest, the risk of capital loss may not be so significant (as long as the dividends are kept up), but most retirees don't think that way.
“So the ultimate conclusion is that persistently low interest rates confront retirees with a dilemma – accept continued poor returns (less than inflation after tax) and adjust your spending accordingly; or take on more investment risk.”
And there is the rub. As we age, our appetite for all manner of risk, and especially when it comes to our money, diminishes.
AMP Capital chief economist Shane Oliver has some words of wisdom for those who want to explore whether they should step outside their investment comfort zone.
“The key for an investor is to work out whether they prefer stability in the value of their investment – in which case bank deposits are a sensible option – or a higher, more stable income flow, whereby Australian shares may be more appropriate,” Dr Oliver writes.
“In any case, in the search for higher yield, investors need to remain alert to opportunities while being aware of how particular shares or assets have performed in the past in relation to dividends.
“But with a low-return outlook and uncertain prospects of capital gains, focusing on opportunities that have a track record of delivering reliable earnings and distribution growth is important if investors are to generate solid returns and meet their investment and financial goals,” he said.
The final nail in the coffin for pensioners is the Federal Government’s deeming rules. Deeming is used to work out the income created from your financial assets. it assumes these assets earn a set rate of income, no matter what they really earn, according to the Human Services Department.
Deeming applies to savings accounts, term deposits and other investments and makes an assumption of what you could be earning in “the market”, even if you choose to keep your money in the bank.
The Government uses deeming to assess the extent of your eligibility for the Age Pension. If you are single and have savings of over $51,200, each dollar above that is assumed to be earning 3.25 per cent interest. If you are part of a couple, the threshold is a combined total of $85,000.
If you are still determined to keep your cash stashed, shop around for the highest interest-bearing accounts. According to comparison website Canstar, you may be surprised how much some will pay. Some savings accounts pay up to 2.9 per cent and some term deposits up to 3 per cent.
Are you concerned that your cash savings are not returning much interest? Do you believe that the Government’s deeming rates exaggerate the interest most pensioners earn from their savings? And if so, should it be lowered? Would you consider seeing a financial adviser to understand if your circumstances and risk-appetite are suited to investing outside of term deposits?