All the anxious talk about “deeming rates” has done one very useful thing: it’s made a lot of people think seriously about what sort of return they are getting on investments in a somewhat strange world of near-zero official interest rates.
Deeming has been around for some time and is basically the rate the government guesses your assets are earning if you are on a part pension or some other benefits – the higher the deeming rate, the higher the assumed returns and thus the lower the government payments.
But similar to the recent uproar over franking credit cash refunds, it was recent media reporting of deeming amid the Reserve Bank’s first rate cuts in almost three years that raised the profile of something many people knew little about, if they’d heard of it at all.
The government on the weekend acted, cutting the deeming rates from 1.75 per cent to 1 per cent for investments up to $51,800 for single pensioners ($86,200 for couples), and from 3.25 per cent to 3 per cent for balances above these levels. Good news? Well, since 2015 when deeming rates were last adjusted, the RBA’s official cash rate has fallen more – from 2.5 per cent to 1 per cent, in turn taking term deposit rates down with it.
But how many people have all their assets in cash, and what’s a reasonable allocation given the risk of going backwards in real terms given very low inflation?
“That depends on how far up the risk curve you want to go,” says financial planner Andrew Heaven, adding that braver souls might keep 10 per cent of their assets in cash and more cautious savers 20 per cent.
Perhaps the bigger question is what on earth do retirees and workers eyeing retirement do for income after watching the cash rate steadily slide from 17 per cent in the early 1990s to near zero (as an aside, they’re negative in parts of Europe)? Reassess return expectations or rethink plans – perhaps already being reflected in the record high participation rate in the workforce – for retirement?
Already, there are signs the sharemarket has benefited from low rates, rising strongly this year as investors buy up stocks with dividend yields north of cash in the bank. “The ASX 200 has returned circa 20 per cent year to date on the back of yields falling,” UBS analysts noted last week, adding dividends to capital growth to arrive at the big number. Government bonds have also attracted flows, the yield on 10-year securities hovering around record lows of 1.3 per cent (yields fall when prices rise).
Heaven, from Sydney-based firm WealthPartners, adds that in the push to diversify away from cash there’s also been a scramble in recent months for higher yielding assets such as bank hybrid securities, pushing prices north of 100 cents in the dollar.
This is Heaven’s big warning: be wary of getting so focussed on yield and not considering risk or capital growth, given that low rates may be around for a while.
As US based fixed interest specialist PIMCO puts it, we’re in a global economy facing “lower growth (particularly given aging demographics in many regions of the world), persistently low inflation, and a likelihood of lower interest rates”.
“We’re beginning to see a few wolves in sheep’s clothing, in terms of products that look like term deposits that aren’t,” Heaven says, adding that getting advice was critical.
Globally, investors have been veering away from public markets for greater returns since the global financial crisis prompted rates to plummet around the world and some stockmarkets to surge. Chris Nicol, an equities strategist at Morgan Stanley, says this is the challenge for investors keen to pile fresh cash into the stockmarket: it’s expensive, trading near record highs.
“Current central bank signalling and current macro conditions warrant defensive positioning yet these defensives are screening quite expensive,” he says.
In a speech this month on “the wellness of investing”, Ravi Menon, managing director of the Monetary Authority of Singapore, notes that the “search for yield” amid low interest rates will inevitably result in investors playing even more in private markets.
“An allocation to investments in private markets is becoming more common – and necessary – for a well-diversified portfolio aiming for decent returns,” he says, pointing to the growth in private equity and venture capital.
In Menon’s eyes, one solution to solving the challenge of people having to fund longer retirements as they live longer and the workforce shrinks is starting retirement planning when young. Arguably, Australia’s superannuation system goes some way to doing just that for younger generations, and many super funds are investing more in private markets like private equity and infrastructure.
But for older folk who worked for years prior to the introduction of compulsory employer superannuation contributions in the 1990s or haven’t built their balances, the headaches from low rates remain.
Philip Lowe, the RBA Governor, acknowledged as much last month after the first of two rate cuts in consecutive months, saying he is reminded of the difficulties facing savers “daily as people write to me telling me how the already low deposit rates are affecting their income”. However, he said lower rates support the economy by putting downward pressure on the exchange rate and because households pay around two dollars in interest for every dollar they receive in interest income.
“We recognise that many Australians have saved hard and rely on interest from term deposits to support their income and spending,” he said.
“(But) the Board considered what was best for the overall economy.”
The overall message?
It’s complex – which I guess is exactly what rates near zero are telling us.
The views expressed are those of the author and do not necessarily reflect those of the Westpac Group.
The information in this article is general information only, it does not constitute any recommendation or advice; it has been prepared without taking into account your personal objectives, financial situation or needs and you should consider its appropriateness with regard to these factors before acting on it. Any taxation position described is a general statement and should only be used as a guide. It does not constitute tax advice and is based on current tax laws and our interpretation. Your individual situation may differ and you should seek independent professional tax advice. You should also consider obtaining personalised advice from a professional financial adviser before making any financial decisions in relation to the matters discussed.