Cause for celebration among mortgage holders, or a blow to savers, the Reserve Bank’s decision to cut the official cash rate to 1.25 per cent is a mixed bag for Australians.
The move to a record-low rate was certainly no surprise, but exactly what that change will mean can be a bit more confusing.
Even where the flow-on effects of the decision are obvious, such as lower mortgage rates, knowing how to best manage the new low-rate environment can often be less straightforward than it might appear at first glance.
The New Daily spoke to Industry Fund Services (IFS) technical, research and advice services chief Craig Sankey to explain some of the implications of lower rates, and what can be done to best take advantage of them.
Mortgages and credit
Australia’s banks were quick to move after the RBA announced its cut, lowering their mortgage interest rates in response (though not all banks dropped equally), and leaving borrowers on variable interest rates a little extra money in their pockets.
For anyone having a hard time working out what to do with that additional cash, Mr Sankey had some advice: if you can afford to, keep making the same repayments now as you were before the rate cuts.
While it may seem counterintuitive, keeping your repayment levels steady will help pay off debt faster and keep the total cost of interest repayments down, saving money over the life of your loan.
For borrowers with a redraw facility, these additional repayments will also build up a pool of additional money which can be used as a buffer if needed.
Many credit card and personal loan products won’t see any reduction in their interest rates as a result of the RBA cut, but Mr Sankey said some borrowers might be able to lower their repayments anyway by consolidating their existing credit and loan products into their mortgage.
In many cases, bringing all of these debts together will mean lower interest is paid on all of them, but Mr Sankey warned anyone going down this route that they will need to add to their mortgage repayments any repayments they were making on the other products too.
“If you’re paying $1000 on a mortgage and $100 on a credit card and put the two together, you need to then start paying $1100 on the consolidated mortgage. Lots of people forget that part, and end up taking a much longer time to pay off their mortgage,” he said.
Successful saver strategy
Lower interest rates unfortunately translate to poorer returns on most savings products, including savings accounts and term deposits – the latter typically delivers better returns than savings accounts, but even their returns have dwindled significantly in recent years.
That presents a difficult environment for people trying to build their wealth, but it’s not an impossible prospect – it just requires a reassessment of how money should be apportioned.
Mr Sankey said investors should take a moment to rethink their portfolio and consider diversifying the types of assets they hold. By placing money into a number of different investments, investors can protect themselves from losses that might be incurred by any one of them, while making money on the others.
But choosing the right type of asset to invest in can be challenging, Mr Sankey said, and you need to consider a range of factors. As a rough guide, people with a long investment horizon (which often still includes people on the cusp of retirement) should look at growth assets like stocks and property.
These sorts of assets will provide income through dividends or rents, but also become more valuable over time so they can typically be sold for a profit. They are, however, riskier than other ‘defensive’ assets like fixed-interest products.
Defensive assets are more suited to people who don’t have time to play catch-up if their investments lose value, those deep into their retirement or those who have earmarked their savings for something already.
How much should you aim to get from your investments? Again, that will vary based on your goals, but in order to make it worthwhile, your returns should still be positive after subtracting taxes, inflation and any fees paid to fund managers or similar.
Mr Sankey recommended using the RBA’s inflation calculator to work out the purchasing power of your money over time, as inflation can readily erode your savings.