Low interest rates and what they mean for your retirement

The Reserve Bank reduced interest rates again in July, down to a record low of just 1% per year.  It means that money is now practically free to borrow.  Now that’s good news if you’re young with a mortgage, but it’s bad news if you’re in retirement trying to live off your savings. 

But there are broader challenges for retirees beyond low interest rates.  The share market is at near record highs, despite the prospects of subdued economic growth.  Keep in mind the Reserve Bank only reduced interest rates because they’re seeking to stimulate the economy in the face of the low growth outlook.

It’s clear the people at the Reserve Bank are concerned about the economy, and retirees should share their concerns.  That’s because investment returns matter most in the years either side of your retirement, when your nest egg is at its largest. 

The last thing you want is to experience investment losses in the years either side of your retirement, particularly during periods of low interest rates. 

Stick to the fundamentals

At times like this, it’s impossible to live off the interest on your term deposits and it can be tempting to chase yield with more complex, higher risk investments.  In the coming months we’re going to see higher interest rate investments advertised.  Company debentures, peer-to-peer lending, mortgage-backed structured investments and more.

But as you’re considering these alternatives, keep in mind the most important rule of investment: only invest in what you completely understand.  If people had respected this rule, we wouldn’t have even had a Global Financial Crisis. 

Do you understand where the return is sourced from?  How do the economics of the investment work?  And where are the risks? 

A framework for investing in retirement

A smarter, and less risky approach is to take a whole-of-portfolio view of your money.  Consider what you need to achieve with your money and invest accordingly.  And only in investments you’re familiar with and completely understand.

In retirement, this generally means setting aside what you need as a safety net, so you know there’s money available if the fridge breaks or if Dad falls over in the shower.  Then set aside enough money to fund your living expenses over the next few years. 

This money should be invested conservatively, maybe in cash, term deposits or bonds.

That sets you free to invest the rest of your money in a diversified manner, maybe in shares, property and infrastructure.  That’s good news because these investments perform differently at different stages of the economic cycle. 

You’ll be able to take a rolling view of your investment returns.  It doesn’t matter if you experience poor returns in the short term because your retirement income is unaffected.  Even when returns are poor, you can still spend your money confident in the knowledge that you’re allowing your investments time to recover.  And if returns are good, you’ll participate in the growth.

Now is not the time for complacency

If you’re approaching retirement, you should start engaging with your financial decisions today.  You’re approaching the ‘retirement risk zone’ and the strategies that have worked in the past aren’t suitable for retirement.

And if you’re already retired, now may be a great time to re-balance your investments.  We’ve had several years of double digit returns, and it’s probable you’re ahead of where you expected to be.  Nobody ever went broke taking a profit, so you should consider de-risking your retirement strategy, by locking in profits on your growth assets.

When it comes to managing your money in retirement, there’s no place for complacency.  That’s why you should have an active relationship with a professional financial adviser.  It’s not a matter of ‘if’, but ‘when’.

Michael Bowman and James McMaster are co-founders of When Financial Solutions