Interest rates have been falling ... and falling. Great if you have a mortgage. Not so rosy if you need income from term deposits. You can get better returns by widening your investment horizons.
But first, why are rates falling? The causes of this fall in interest rates are complex. Here in New Zealand our interest rates are set by the Reserve Bank of New Zealand, which is required to meet employment and inflation targets and its main tool to do that is interest rates, says Kiwibank's chief economist Jarrod Kerr.
Kerr and his team are predicting that the official cash rate, which governs mortgage and savings rates, could fall to 0.5 per cent or at worst 0.25 per cent by the middle of next year from the current 1 per cent. Mortgages and term deposit rates would most likely fall by a similar percentage. Those low interest rates are a real bonus for Kiwis who are paying mortgages, but not savers.
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If you're saving for the future or trying to supplement New Zealand Superannuation with income from term deposits, then 2.5 per cent interest and falling is painful.
It may be time to try other investments. The most obvious are lower-risk managed funds such as fixed interest, or income funds.
Also popular at this end of the market are diversified funds that spread your money widely across different geographies and types of investments such as shares, bonds and property. When one component of the fund is having a down year the others should be making up for it.
The move to funds is already being seen. Mike Heath, general manager of InvestNow, a fund supermarket, says there is clear evidence of investors are dipping their toes into funds. "Back in March this year only 10 per cent of our total funds under management was held in fixed-interest/cash/cash-equivalent funds," says Heath. Now that's 13 per cent. "So that's a relative 30 per cent increase in the past six months."
Most of these funds are "Pie funds", which are taxed at a lower rate than most people's personal tax rates. "Every little bit helps when an investor is looking for income from their hard-earned cash," says Heath.
that KiwiSaver funds are another option, says Tom Hartmann from the Commission for Financial Capability. They come in the same wide variety as ordinary managed funds, are also taxed at the lower Pie rate and often have lower costs. After the age of 65 you can make regular withdrawals from KiwiSaver funds.
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Hartmann says when you switch from term deposits to funds you need to take into account the level of risk. The difference may not be huge, but it is real. "If you forget we are taking on higher risk you could get stung," says Hartmann.
Of course every investment including term deposits has risks. The types of funds term deposit investors are moving to tend to be the less volatile ones and when funds do take a dive they inevitably recover over time providing they're invested widely.
Take the AMP Balanced Fund. Like most funds it took a hit in the Global Financial Crisis of 2008. It had regained the lost ground by 2011. Money invested in this fund in 2008/9 when the financial world was in turmoil is now worth roughly double what it was then.
The other issue to keep at the back of your mind is the spectre of negative interest rates. If you think 2.5 per cent is bad on savings, imagine -0.5 per cent. Your term deposit would be worth less at the end of the year and you wouldn't receive interest, says Kerr.
If you have a mortgage the outstanding balance drops each year when there is a negative interest rate without you making a payment. Good as it sounds, none of us should wish for negative interest rates because they can make a mess of the economy, which in turn affects our main source of money: jobs.