On Tuesday 3rd February Glenn Stevens and his Reserve Bank of Australia (RBA) board members made the decision to cut the cash rate to a new low of 2.25%.
Record low rates signal unprecedented times for borrowers and lenders. They may also signal that it’s time to rethink your own financial strategy.
Low cash rates will usually be passed on by the banks which means lower interest rates for most products including bank savings accounts, term deposits, investment loans and home loans. Many of you would be familiar with the terms ‘buyers market’ and ‘sellers market’ when discussing property; likewise low interest rates create a ‘borrowers market’ and high interest rates create a ‘lenders market’.
Today, we are undoubtedly in a borrowers market.
In the current environment you may borrow money cheaply due to the low interest rates on offer, however the money you lend to the banks (in the form of term deposits and cash accounts) will be poorly rewarded with only low levels on interest available for your savings. There are two significant flow-on effects due to the current record low interest rates:
1) It’s time to reconsider the traditional approach of paying down your mortgage as quickly as possible.
With 3-year fixed home loan rates close to 4.5% it may be best to consider other uses for those extra repayments that you’ve been kicking into your home loan every month. It may be prudent to assess other options for these funds such as direct investment strategies or increasing salary sacrifice to your super. These strategies are going to depend greatly on your tax rates, risk tolerance and investment horizon but may be a more intelligent approach to building your wealth in the current environment.
2) Cash and term deposits have all become ‘parking’ accounts
For those who have now paid down their debts and are looking to build your wealth or perhaps retire comfortably, you are not going to get the same bang for your buck that you did in the past.
Term deposit rates have fallen below 3.5% and if you are paying tax on this interest you may be hard pressed to keep pace with inflation.
If you are retired and trying to fund a modest lifestyle of $50,000 without eating into your savings, you will now require in excess of $1.4m in bank deposits to avoid making lifestyle compromises. This has been a key contributor to the significant price growth for shares such as Telstra and the Big 4 banks, with poor cash returns leaving many investors on the hunt for strong dividend-paying stocks.
As with mortgagees, record low rates mean that it’s probably high time to reconsider your investment approach and make sure that your hard-earned money is working for you.
Finally, low rates create a very competitive environment where banks must put their best offers on the table to incite new customers to deposit or borrow money. This is a time when independent advice can be incredibly valuable – be it financial advice, mortgage broking or accounting advice. Independent professionals are better positioned to consider all offers available rather than steering you toward their employer’s products. When you are seeking to get the most from your finances, unbiased professional recommendations can add tremendous value and may just offer the extra push needed to get your wealth plan on track!
James O’Reilly is the Director of Northeast, a fast-growing financial advice firm that empowers clients to achieve meaningful financial progress and well-being. He's also the co-host of the Australian Retirement Podcast, one of Australia's fastest-growing podcasts.