One of the key determinants of term deposit rates is the Official Cash Rate (OCR), which is the principal monetary policy tool used by the Reserve Bank to maintain price stability. Reducing the OCR has a stimulatory effect on the economy, as borrowers take advantage of lower rates to spend more. Eventually the increased demand for goods and services leads to higher inflation. While the focus of the Reserve Bank’s current policy of reducing the OCR is on borrowers, the flip side is that investors are also affected. When interest rates are high, investors are happy and borrowers suffer. Conversely, low interest rates lead to grumpy investors and delighted borrowers.
Of course the good news is that while interest rates are low, inflation is at a historical low of less than 1%. Looking ahead, it is clear that the Reserve Bank is intent on keeping interest rates low, resulting in a stimulus to the economy that will see inflation increasing over the next two years or so to around 2%. This is bad news indeed for retirees who are reliant on interest income. The result could be investment returns of less than 1% after tax and inflation. Retired investors should review their strategies and consider alternatives to term deposits. They should be prepared to let go of the notion that their retirement capital must be left untouched and that their income is restricted to investment returns. The key financial challenge for retirement is to run down capital in a planned fashion. A conservative approach is to plan to live for a long time to avoid the worst case scenario of running out of money before the end of life.
These are difficult times for risk-averse investors and careful planning will be required to deal with the tough times ahead.