Things could get a little bit messy

Bruce Brammall, The Australian, 17 April, 2022

17 April HS 3

Let’s me put a bit of a bent on an old saying: “Enjoy the chocolate Easter eggs today … because it’s going to be boiled lollies for Christmas”.

For the first time in nearly 12 years, we’ve had an interest rate rise. Actually, there’ll be many. It doesn’t matter which colour wins on May 21.

This came as a result of what everyone already knew was happening – everything seems to be costing more. That’s partly because of supply constraints (shop shelves still aren’t full) and partly because of demand (overall, people have more money). You can add in other ingredients too, such as the national staffing crisis.

The second point is what’s going to cause the first point. The Reserve Bank fights inflation by raising the cost of money. Take money away from borrowers, so they can’t spend more, which should slow the rising cost of living.

But there are a lot of people out there for whom an increase in interest rates is not going to have a great impact. They don’t have debt, either because they never did, or because they’ve paid it off (or nearly have).

And there are those, of course, who will welcome an increase in the cost of money because they are net savers, who will benefit from higher interest rates.

Okay Boomers

It’s generally older Australians who are in these positions.

They’ve made it through their 50s, are possibly in the decades beyond that. They have paid off their home, have positively geared property and share portfolios, or have got to the point where their debt is simply not the burden it once was.

The big expenses of raising kids and mortgages are behind them. And all of a sudden, they’ve found their cash stocks are growing, possibly even into “stock piles”.

It’s largely Boomers and older Gen Xers in this position. And, while it’s a nice position to be in, holding too much cash can also be an issue.

When interest rates are this low, holding cash means watching your savings go backwards.

Even if you’re earning 1 per cent, with inflation at 3.5 per cent, the real value of your savings is falling.

Moving to next

All investment involves risk. While cash in a bank account (up to $250,000) is guaranteed by the government, the risk is largely as above.

There is a limit to how much anyone needs to hold for “rainy day” purposes, simply for liquidity. Only you can know how much that is. Some might only need $5000-10,000. Others will need $50,000-100,000 to feel safe.

But savings in excess of your personal “safety” requirements, in general, should be considered for investment. It becomes a matter of in what you’re going to invest, and how.

The “how”

The how is the vehicle you’re going to use. That means either investing in your personal name, or potentially via superannuation.

(There are other options, such as trusts and companies, but personal name and super are the two most easily accessible.)

As with everything financial, there’s no one-size-fits-all solution here. For some, superannuation will be the best opportunity. For others, super might not be an option at all. And for others still, it will be a combination of both.

Super is a (generally) lower-tax vehicle. You can potentially get tax deductions for contributing to super. And the money your super fund earns will pay a maximum of 15 per cent in tax, or potentially 0 per cent tax for those who are drawing a pension.

But there are limitations to both getting money into and out of super.

Investing in your own name has no such restrictions on access or amounts. But you pay higher taxes in general, up to 47 per cent.

What is right for you depends, completely, on your personal circumstances. For many, investing should be done both via super and non-super means, because there are limits to how much you can get into super and how much you can afford to lock away for an extended period, given age.

If you’re not sure, don’t guess. Get professional advice.

The “what”

The investment opportunities inside or outside super are largely similar. There are a few investments that super funds, particularly regular super funds, can’t make.

But the main options come in the same four spaces – shares, property, fixed interest and cash.

That list is, not coincidentally, the order in which long-term returns tend to be generated, from highest to lowest. That is, over the longer-term, shares should beat property, which should beat fixed interest, which should beat cash.

That’s also where the risks are, from highest to lowest.

Determining where your money is invested should never be about chasing the highest returns. You might want the sort of returns that are achievable with  shares, but can you handle the occasional, violent, falls?

Instead, what you invest in needs to reflect both how much risk you are prepared to take and over what timeframe you are investing.

Your risk profile

Some argue your risk profile is unique to you. And, ultimately, it probably should be.

But for those starting out taking an active interest in investing, let’s talk in general about the limited, broad, risk profiles that most people will fit into.

The “average” investor is someone who wants to take some risk, but isn’t prepared to throw the lot into shares and property.

That would generally be about two-thirds (between 60 and 70 per cent) of money sitting in the growth assets categories, which is shares and property.

The remainder (about 30-40 per cent) would be in the defensive asset classes of cash and fixed interest.

Over 5-7 years, this kind of risk profile has generated about 7.5 to 8 per cent returns, before fees.

Obviously, you can take more or less risk than that. Higher-risk investors, known as “growth”, “high growth” or “aggressive” investors, will have a higher proportion of their money in shares and property.

Lower-risk investors, who want to be more conservative with their investments and are prepared to accept lower returns as a result, will have a higher proportion in fixed interest and cash.

During the bad times?

What can happen when things go pear-shaped? During the Corona-crash, between 21 February, 2020 and 23 March, 2020, when world investment markets collapsed in panic, high-growth investors lost in excess of 30 per cent, while lower-risk investors generally lost around 10 per cent.

Those sitting in cash during that period, of course, lost nothing.

When the sun shines

And how about the good times?

In the roughly 21 months that followed the Corona-crash, high-growth investors made in excess of 60 per cent, while even low-risk investors made well into the teens.

Those fully invested in cash, of course, watched their money slowly go backwards. While interest rates were at zero, inflation gnawed away at it a bit.

How do you find out your risk profile? There are plenty of free, simple, risk profiles available online. Be a bit wary of which ones you choose. And if they’re trying to flog you something at the end, don’t just buy.

And if it leaves you confused … get advice.

Chocolates and boiled lollies

While the Reserve Bank has not raised the official interest rate, the cost of money has already increased.

If you want to fix your home loan for 3-5 years, it no longer starts with a “1”, but generally a “3”. It’s variable rates that will start moving north, when the RBA pulls the trigger.

There is pain coming for those with mortgages. How much is not certain, but debt markets are pricing in “agony” by this time next year. They might be over-egging the risks.

It’s still likely to be some time before interest rates for cash savings are likely to lift significantly.

For those who have come out the other side of the pandemic (are we there yet?) in reasonable shape, is it time for you to do something about that?

Bruce Brammall is both a financial adviser and mortgage broker and author of books including Debt Man Walking. E: bruce@brucebrammallfinancial.com.au.

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