Don’t let low rates spoil your retirement plans

Angus Sippe
Angus Sippe
Schroders Fund Manager, Multi-Asset, Australia
Low cash rates have dragged down private pension payments and impaired returns on super balances. Fortunately there are steps that can be taken at all life stages to combat the challenges of low rates.

Official interest rates in Australia are currently at a historic low of 0.10%. If you’ve had a variable mortgage in recent years, then you would’ve appreciated the fall in rates. But as an investor, low rates are hurting the cash portion of your super savings.

If you haven't already retired, you might be finding it harder to generate your desired level of cash flow from your income-producing assets. And, if you're yet to retire, low rates may be holding your super back from reaching the balance required for a comfortable retirement. This balance is considered to be $640,000 for couples and $545,000 for single people, according to the Association of Superannuation Funds of Australia's Retirement Standard. That works out at $43,901 for a single person and $62,803 for a couple each year.

Risk is also important. If you’re in your 50s, 60s or retired, capital stability is likely to be a high priority. And the benefit of cash is the capital protection that it offers. However, very low interest rates could actually be eroding the value of your investment when the effects of inflation[1] are taken into account. What this means is that in 10 years’ time your savings would buy less than they would today.   

At the moment, every week that you are invested in cash, the value of your investment is being eroded by inflation.
Following the impact of the COVID-19 lockdowns on business and consumers, Central Banks have indicated that they will keep rates low for longer to promote economic growth. Fortunately, there is a range of strategies that can help combat the effect of low rates.

1. Invest in actively managed, higher-yielding fixed income

Fixed income investments are government or corporate bonds that pay investors a fixed, regular amount and repay the principal at maturity. They offer a wide universe of opportunities for the defensive part of your portfolio across the type of bond, industry and country of origin.

You can meaningfully increase returns with little additional risk by allocating part of your cash portfolios to fixed-income investments. Taking an active approach to fixed income through a professionally managed, liquid, high-quality portfolio of fixed income investments allows you to benefit from broader opportunities while reducing additional risks.

Investing in this style of fund offers the potential for a higher return than available from cash. And while it brings a proportionate level of risk, this is mitigated by broad diversification.  

Investors can meaningfully increase returns with some additional risk by allocating part of their cash portfolios to fixed income investments.

2. Consider increasing your allocation to growth assets

The effects of low interest rates are pushing the prices of growth assets, like shares, higher. That’s good news for all share investors, regardless of their life stage, and particularly beneficial if you’re in your 20s, 30s or 40s. This is because you have the time horizon to benefit from investing a greater portion of your portfolio in growth assets, which offer a higher potential return but have high risk. For a portion of your investment portfolio, consider actively managed, diversified managed funds that invest in a broad mix of Australian shares, overseas shares, private equity or property.

3. Review your retirement target date

If you’re still working, assess whether the retirement date in your financial plan is still a good fit for you. Perhaps you’re open to working for longer, but part time? Working for longer pushes out your investment time horizon. This in turn creates an opportunity for more of your portfolio to be allocated to growth assets – investments that offer a higher potential investment return at a higher risk.     

4.     Make additional super contributions

Another way to offset the impact of low rates on your super balance is to make additional contributions.

If you’re 65 or older, you may be eligible to make a downsizer contribution of up to $300,000. 

Still working? You can make an after-tax contribution, or you can set up salary sacrificing contributions. This involves making an agreement with your employer to receive less income before tax in return for them making additional super contributions on your behalf. And the earlier you start making additional contributions, the greater the power of compound interest.

5. Talk to your adviser about overcoming the challenges of low rates

Just because interest rates are low, you don’t have to lower your retirement expectations — as long as you explore your options and do some planning.

Your adviser can help you review how your retirement savings projections have been impacted by low rates and where the opportunities are to enhance your portfolio outcomes.

    Top tips for investing in a low rate environment

    • Re-allocate some cash to actively managed, higher-yielding fixed-income funds for some additional risk.
    • If retirement is still some years away, consider increasing your allocation to growth assets which offer a higher return potential for higher risk.
    • Review whether your retirement target date is still a good fit for you. If you’re thinking of working longer, that extra time will give you an advantage.
    • Making additional super contributions can offset the drag caused by low rates. Tax incentives may be available.
    • Your adviser can help you review how your retirement plans have been impacted by low rates and propose strategies to combat them.

    [1] Inflation in Australia is measured by the Australian Bureau of Statistics. The Consumer Price Index for the 12 months to December 2020 rose 0.90% - nine times higher than the official interest rate of 0.10%.

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