Q: We are self-funded retirees and rely on returns from shares and Term deposits to meet our income needs. With Term deposit rates falling to a ridiculous level, we have to think of alternate investment for our term deposit money. What should we do?
A: The recent RBA interest rate announcement has cut the Cash target rate to a record low of 0.75%. By comparison in 2014, the Cash target rate was 2.50%, an incredible cut of 70% in just five years. The consequence for investors is those who have 5-year term deposits maturing in the near future will need to expect renewal Term deposit rates of around 1.6% as opposed to the 4.5% they were previously receiving.
Share market volatility has focussed investor sentiment on the importance of preservation of capital. However, with the sharp fall in interest rates and the consequences for returns from fixed interest investments, capital risk has been replaced by income risk as a key consideration for retirees.
Locking in longer duration Term deposits now in a low-interest-rate environment really doesn’t make sense unless you feel interest rates will remain lower in the longer term.
Consider “high interest” savings accounts as an alternative to Term deposits, as the rates on offer may be higher provided you meet the ongoing deposit requirements.
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 manage income risk.
The key principle of portfolio construction is to derive the optimal rate of return with an acceptable level of risk over the required time period of the investment.
Trying to time investing is fraught and often causes more damage to total wealth. For example, in the past 12 months, the All Ordinaries index has risen by 8%, however, the index performance has ranged between -9% and + 13% within this period.
When investing in equities for income purposes, look to the future but be 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 look relatively attractive but there are negatives. Direct property is illiquid; you can’t sell off the back room if you need partial access to capital. Prolonged periods without tenants also adds additional income risks.
Managed funds provide an excellent opportunity to gain exposure to a range of asset classes and to diversify your portfolio. Quality managers add value and reduce risk. 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.
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.
You should seek professional advice, at the very least to gain an opinion on the likely risks you face; both capital and income.