Low interest rates create a variety of opportunities, depending on what stage you’re at in life and what you’re looking to achieve with your finances.
If you’re a borrower, low interest rates represent an opportunity to lock in part of your home loan at a low fixed rate to provide some insurance against rates going up.
So if you think we’re at a low point in the cycle and you can get a good deal, there’s an argument for fixing your home loan rate.
But deciding between fixed and variable rates is a decision that Australian borrowers have usually got wrong over the years.
Many people tend to lock in their rate only at the top of the cycle and before they know it, the variable rate has fallen below the fixed rate.
If you have a substantial home loan, low interest rates are a good opportunity to pay down your home loan faster.
You may feel that your home loan is too big to think about other investments beyond your superannuation. So it could make sense to pay down your home loan faster until you’re more comfortable with your home loan and you can then allocate that money to investing elsewhere.
If you’re a self-funded retiree and you’re relying on bank interest to provide you with an income, there’s no doubt that low rates are bad news.
A few years ago, term deposits were attractive because they provided a good return relative to inflation, a good cash flow and a safe haven for investors nervous about sharemarkets. They might still be a safe haven but the rate of return is a lot lower.
But rather than despair at the low returns, there are alternatives out there that may provide decent rates of return.
So if you’re an investor, low interest rates present an opportunity because they make the income from shares and other growth assets more attractive than the income from defensive assets like term deposits.
The average yield on unlisted commercial property investments is over 6%, real estate investment trusts are around 5.5% and shares with franking credits are delivering around 5.5% to 5.7% on average. Investors can get quite a decent income from stocks that tend to provide relatively high dividend yields like banks, telcos and utilities.
By contrast, term deposit rates are well below the dividend yield for shares and residential rental properties aren’t much better right now – after cost and tax the yield is actually quite low.
Of course, shares do have more volatility so there is increased risk. But low interest rates make riskier strategies like gearing more attractive because it means there is a higher probability that the money you make from shares will exceed the interest you’re paying on your borrowing. That holds whether you’re in a geared fund or you’re using your home loan to finance your investments.
And lower interest rates also provide confidence that at some point down the track economic activity and company profits will pick up, which in turn helps the sharemarket.
Over the past few years global interest rates have stayed at pretty low levels. And that could be a guide to what Australia’s in for.
I think at some point interest rates will start to rise again, maybe later this year. But they may only go up slowly because we have a world awash with savings and spare capacity, and that keeps inflation relatively low.
In Australia with the mining investment boom steadily fading away we’re not going to return to really strong growth any time soon.
And as the years go by, fiscal austerity such as that flowing from the recent Budget may start to bear down on economic growth. So the Reserve Bank will probably be forced to keep interest rates at relatively low levels for some time to come, even if we have seen the low point.
Investors may therefore face a lengthy period when returns from bank deposits remain fairly low and they need to think about ways to adjust their strategy to compensate from this and/or benefit from it.
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