Lower for longer: Outlook for interest rates
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Despite a bigger than expected economic rebound, interest rates are likely to stay at record lows for the foreseeable future. So, what does that mean for retirees who are trying to live off their retirement savings? And what should they be doing right now to make the most of the economic conditions?
Rates to stay low
In March the US Federal Reserve announced its intention to keep interest rates at record lows for the foreseeable future. Despite the economic recovery accelerating, inflation rates in the US are still below 2% a year. The Fed wants to see inflation track higher than 2% a year for some time in order to achieve its long-term inflation target.
That means that interest rates are unlikely to rise in the US until at least 2023.
Here in Australia, the economy has also bounced back faster than expected, with economic output now expected to return to pre-Covid levels by the middle of the year. Despite inflation forecasts increasing slightly, the Reserve Bank does not expect to start increasing interest rates until at least 2024.
Search for yield
With interest rates at record lows, it can be tempting for retirees to look beyond cash and term deposits for higher returns. Some retirees are switching from cash and investing more into the share market so they can earn dividend income. With investor sentiment so positive at the moment that may seem logical. But keep in mind that shares are riskier investments than term deposits because share prices rise and fall.
Most retirees are more conservative now than they were when they were younger. So, retirees should be careful not to unwittingly expose themselves to more risk than they’re comfortable with.
A better approach for retirees
Too much in cash can drag on the performance of a retiree’s super balance.
But cash and term deposits have a role to play even when interest rates are low. Cash can provide much needed diversification and protection from investment shocks. It can create a liquidity so there’s access to money when needed, and it can be used to fund withdrawals, so there is money to live on.
That’s why we often recommend our clients set aside some cash to draw down regularly.
Typically, retirees might set aside enough to live on for two to three years, and then invest the rest in a broadly diversified way across shares and property. That sets them free to spend irrespective of the market conditions, and if markets have performed well, like recently, retirees can rebalance their investments and top-up their cash. And during periods of poor returns, the cash they hold should allow them to stay the course.
If you’re a retiree and concerned about low interest rates, it’s important to speak with an expert. At When Financial Solutions, we understand the complexities of investing for retirement. We understand you need to balance your short-term and long-term risks, all while drawing income to live on.
That’s why, if you partner with us, it’s not a matter of ‘if’ you will make the most of the low interest rate environment, but ‘when’.
Michael Bowman and James McMaster are co-founders of When Financial Solutions. This article is general and does not consider your personal circumstances so it may not be appropriate to you. If you would like advice specific to you, please give us a call.