Interest rates are the lowest they have been since the early 1960s1. That’s great news for homebuyers, but what’s the best way to manage your money in this environment?
Tip #1: Hunt for yield
Low interest rates are bad news for savings, and high-interest savings accounts and term deposits are probably not pulling their weight when it comes to returns. If your interest is lower than the rate of inflation, your savings are actually losing value and it’s time to consider other options.
In October 2015, Canstar3 reported the highest 12 month term deposit rate on offer in its database was just 2.95 per cent. With inflation running at 1.5 per cent, and the typical marginal tax rate 34.5 per cent, many investors are lucky to break even.
This makes equity markets look more attractive. Lower interest rates tend to lift share prices because company earnings often increase, and shares with dividends look appealing. Of course, there are no guarantees – companies don’t have to pay dividends. Meanwhile, with few alternatives for high yield investments, some analysts believe parts of the equity market could be over-valued.
Lured into the market by the low cost of borrowing and potential for capital gain, property investors also need to be wary of the rental return. If you’re paying the highest marginal tax rate of 47 per cent, you’ll need a rental yield of 2.94 per cent just to break even on the cost of your investment property loan3 (before factoring in any potential benefits of negative gearing). Rising house prices make this a challenge: in Sydney, the average gross rental yield for houses hit a new record low of 3.1 per cent4 at the end of September 2015.
Tip #2: Get smart about gearing
Yield concerns certainly haven’t held property investors back - investment property loans grew by 10.4 per cent in the year to March 20155. It’s tempting to borrow to invest when cash is so cheap, but be careful not to over-commit. And if you’re thinking about gearing to buy shares, look for positive gearing opportunities rather than making a loss to claim back on your tax return.
Tip #3: Diversification is the name of the game
It’s important to balance capital stability and a steady income stream, so spreading your investments across cash, term deposits, property and shares will help you manage risk and return. If you stagger the maturity dates for cash and term deposits, you can mitigate the impact of the current low rates.
If you stagger the maturity dates for cash and term deposits, you can mitigate the impact of the current low rates.
Tip #4: What goes down will eventually go back up
Although it seems likely the Reserve Bank of Australia will keep interest rates low a little longer, and perhaps even make a further cut6, nothing is certain.
So if you’d like a little more confidence in your monthly budget, now might be the time to fix part of your investment or home loans. And make sure you build in a buffer. Could you absorb a 200 basis point rise7? If not, re-think your loan – now is not the time to get complacent or risk your repayments.
Tip #5: Shave years off your home loan – and save
Now’s the perfect time to get on top of your home loan by paying more than the minimum repayment. Alternatively, pay fortnightly rather than monthly and you’ll easily make a few extra payments each year. You could take years off your loan – and give yourself a comfortable buffer when rates rise again.
For example, an extra $300 each month on a 25 year 4.5 per cent interest loan on $300,000 could save you $55,000 in interest2 – and see your mortgage paid off almost seven years sooner.