Interest rates are low! If you didn’t already know, you’ve obviously been stranded on a desert island with a soccer ball as your only companion for the last two years.
There’s no denying that the topic of interest rates and guessing games as to which way the Reserve Bank might take them each month, are high on the media’s agenda.
Not to mention the general demonizing of investors, accused of collectively blowing the mother of all property bubbles by taking advantage of said low rates to shore up their portfolios and self-fund retirement. The nerve!
Receiving less airtime however, is the impact this prolonged low interest rate environment is having on cash investments, and the large number of retirees who rely on them.
When savings won’t cut it
A lot of younger baby boomers and older Gen X-ers are staring down the barrel of retirement and facing a longer post-work period than our forebears, with life expectancy projections climbing into the nineties.
Most of us will have to find sufficient income to sustain our ideal retirement lifestyle for at least twenty to thirty years.
Unfortunately, the 2008 GFC saw many a super fund decimated, while share portfolios took a serious battering, leaving a large amount of mid-lifers with little or no ‘nest egg’ to speak of.
Some might only have ten to twenty years in which to claw back their financial stability and ensure they won’t have to rely on the aged pension in retirement. Let’s face it; you can’t really live it up on government assistance.
So what about savings accounts and things like bonds, which have traditionally been favoured by risk adverse Aussie investors, over more volatile, high growth commodities?
Sure, cash reserves are a must have in any well-balanced investment portfolio, particularly when you have riskier assets to protect and in the case of property investors, gearing to accommodate.
But these days, you cannot rely on savings alone to bear sufficient fruit for your retirement fund.
What about super?
Let’s reflect for a moment on the thoughts shared by the illustrious Joe Hockey and co. who claim, “Income from savings contributes to a person’s ability to pay tax.”
This little gem is a prelude to the treasury’s anticipated announcement around intentions to reform taxes on domestic savings, including super funds.
As if standard managed funds weren’t already questionable in terms of their reliability to deliver consistent retirement income as a stand-alone investment vehicle.
One in, all in
While homeowners and property investors are rejoicing our low rate environment, many retirees who’d stashed their cash safely in term deposits are realising why saving your pennies is not a sound investment strategy.
Where living off interest earned on savings might have been do-able when the cash rate was closer to ten than two, it’s now nigh on impossible unless you have a million or so lying around.
A quick glance at RateCity’s website comparison guide reveals an average rate on high yield savings accounts of between 1 and 2 per cent (at time of writing). Some are as low as 0.5 per cent…hardly worth the effort to open one really.
So what’s an equity rich homeowner to do when facing the prospect of a prolonged retirement, with little in the way of a cash bucket to draw on in order to fund it?
Invest in property
When you consider the negligible interest paid on savings accounts and the need for many to recover their retirement funds in a relatively short space of time, it’s understandable that more Australians are turning to bricks and mortar assets.
In fact we’re currently in the midst of the perfect investment storm. Attractive capital growth across premium property markets, ‘cheap debt’, lenders vying for business and low vacancy rates are creating ideal conditions in which to hold residential property in your portfolio.
Not to mention the fact that we just love anything to do with houses!
Our adoration of accommodation aside, it really does make sense that more of us are finally starting to recognise the multiple benefits, including tax savings and demonstrated market reliability, of property investment to fund retirement.
Particularly when you consider that even at a top rate of 3.85 per cent – the highest we found on RateCity – properly selected housing is likely to outperform savings accounts by around 10 per cent per annum (based on a conservative average capital growth estimate of 8% and rental yield of 5% PA).
In other words, a $100,000 savings account will deliver a gross return of around $2,000 each year (at a higher retail rate of 2%), whereas the same $100,000 invested in property would deliver a gross return of around $13,000.
Then of course there’s inflation to account for, and we haven’t even touched on the notion of taxes yet. Remember, negative gearing and depreciation incentives allow investors to retain more of their real estate returns.
As opposed to the tax applied to interest earned from high yield accounts, which is payable at the same rate as your income tax bracket. In other words, you could conceivably lose close to half of that $2,000 gross return when the taxman takes his share.
Other ways to save
Of course I’m not in any way suggesting you should put all of your investment eggs in the one, higher risk commodities basket that is shares and property.
Your portfolio should be well balanced and planned to accommodate your current circumstances, your risk profile as an investor and long-term objectives when it comes to your financial future.
Cashflow is essential to sustain any type of investment portfolio, so you need a buffer in case of things like extended vacancies, unexpected maintenance costs and/or loss of income.
How and where you stash your cash will make a significant difference to your overall wealth position in years to come though. So it’s important that you think about this as part of your overall investment strategy.
One of the ways you can make your cash investment work harder for you is to put it toward non-tax deductible property debt. This could be in the form of an offset account linked to your home loan, or even additional payments toward the mortgage on your PPOR.
While property investors are wise to spread risk across different commodities, including the safety of cash reserves, believing that term deposits will net you sufficient growth to pay for retirement is a little too optimistic.
Not only is well-selected real estate a proven performer, it once again trumps most other investment vehicles and remains a favourable asset in this lower interest rate environment.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).