Rates, Risk & Return

James McKelvie

Australia's economy got another kick at the beginning of July as the Reserve Bank of Australia (RBA) lowered interest rates to new lows of 1.00%. This followed the Reserve Bank of New Zealand's (RBNZ) move to historic lows of 1.5% a few months earlier - both banks looking to stimulate growth in their economies and support the outlook for employment and inflation. 'Don't you go out in the rain' could be heard in the background as the RBNZ Governor inadvertently (or not) encouraged people to get a roof over their head by providing relief to borrowers. Borrowers may now be able to afford more debt to buy the things they want, and this is meant to stimulate the economy.

The other side of the equation is the sting savers will feel as they begin to receive less interest from their bank account. The chart below compares how cash has performed against other asset classes. Savers will find themselves going forward in a position where after tax and inflation, the real value of their savings is being eroded. This is about the only certainty in today's economic environment.




Data Source: Morningstar (returns) and RBNZ (inflation)

With lower returns at the bank, investors need to look further afield to other fixed interest or growth investments for return on investment. To gain the same return as before, investors will end up paying a higher premium; they will need to take on more risk. Past returns are not an indication of future performance, and the more risk an investor takes on for yield and or capital gain, the greater the potential for loss.

As interest rates fall, bond prices rise, providing capital gains for investors. The 10-year New Zealand Government bond yield just hit all-time lows in June of 2019 suggesting a low interest rate environment is likely to stay. A crowded house of dividend paying shares has risen in price too as investors are more willing to accept share market risks for a more attractive yield.

It's yet to be seen if the interest rate cuts will have an inflationary effect on property, and movement in this market might not be for some time. Possibly apartments suffer in the short term as more continue to be built, however houses remain in demand and in limited supply. The appeal of rental yields, the end of capital gain tax and the attractive mortgage rates for first home buyers might suggest the recently turbulent economy has the potential to get back in black.

How much risk should you be taking with your money?

Considering the appropriate amount of risk you are willing to take on is important to balance with investing. This means determining and agreeing the most fitting mix of cash, fixed interest, shares and property within your portfolio. Most people would have completed some sort of risk tolerance profiling questionnaire during their investing lives, but this isn't the be all and end all of investment selection – included is how much risk do you need to take on to achieve the returns you want? What is your perception and understanding of the risks involved? These are the types of discussions you will need to have with a financial adviser to narrow down what are the most governing elements of your risk profile to create an investment program suited to your long-term needs.