Q. We are self-funded retirees and realize that now with very low interest rates which are tipped to remain for a long period, we have to think of alternate investment for our term deposit money.

We rely on returns for income and would appreciate your thoughts on what we should do. We have shares which are on a high and we are very wary of managed funds.

A.  The announcement of the RBA on Tuesday to cut cash rates to 2.75% is the 7th cut since November 2010.  The consequence for investors is that as Term Deposits mature they are likely to see available rates cut by 50% compared to those available in 2010. According to an ASIC study released in 2010, 45% of all Term Deposits belong to investors aged 65 or older so rate cuts impact greatly those of retirement age.

In the aftermath of the GFC the focus has been on the preservation of capital.  Investors have been happy to ride out the storm in the relative safe haven of cash and fixed interest.  That has come at a cost, in a lower interest rate environment, Capital risk has been replaced by income risk as a key consideration for retirees.

The pursuit of higher income or yield will drive investors to other asset classes.  In the current climate for retirees, preservation of income is the key.  In order to secure income, retirees will need to accept more capital risk to remove income risk.

The key principle of portfolio construction is to derive the optimal rate of return with an acceptable level of risk.  Trying to time the market is fraught and often causes more damage to total wealth.  In the past year, the Australian Sharemarket has risen by 20%.  Missing this rally would have been expensive.

Locking in to longer duration Term deposits now in a low interest rate environment doesn’t make sense unless you feel interest rates will remain lower in the longer term.

If considering Term deposits, check out “at Call” Internet based savings accounts as the rates on offer may be higher.

Hybrid securities are marketed as Fixed Interest investments but often have equity like risks without the equity like upside.

When investing in equities for income purposes, look to the future but me mindful of the past.  Look at the forecasts for the future earnings of the company, the retained earnings of the business and the consistency of dividends declared and the payout ratio.

For property, yields are looking more attractive but the asset is illiquid; you cant sell off the back room.  Prolonged periods without tenants also adds additional income risks.

Managed funds provide an excellent opportunity to gain exposure to various asset classes.  Quality managers add value and reduce risk to portfolios.  There are several research houses that rate managed funds against their relative benchmarks and their peers.  Ensure the managers you consider are well rated and are aligned to your income and growth needs.  A Financial Planner will be able to blend a portfolio of managed funds across a range of asset classes.

How you invest your portfolio should be determined by your income needs, your risk profile (how much volatility you can afford to bare) and most importantly your investment time frame.



Follow Andrew on Twitter @AndrewHeavenFP.  This article was originally published in The Australian.