RBA's interest strategy puts retirees in a fix

The situation is poised to create terrible pressure. Hybrids generally don't have to pay you interest.

WHEN the Reserve Bank of Australia (RBA) dropped the cash rate to 3.25 per cent almost three weeks ago, mortgage-holders were happy but retirees and savers must have felt they'd missed out.

The cut in the cash rate reduced the cost of money to a range that it has only been in once in the past 50 years. That previous period, February to October 2009, was when the cash rate bounced around between 3 per cent and 3.25 per cent, in the backwash of the GFC.

Now we're back in that range and while mortgage-holders stand to save about $38 a month on a $300,000 variable rate loan, there are numerically more Australians saving their money and relying on the yield from those savings than there are people borrowing and buying.

The people who have their money in cash savings products - term deposits, online savings accounts, bonus savers - are relying on interest rates to sustain them. But the RBA wants to stimulate the economy - especially the flagging housing sector - so it reduces the cost of money to get people to borrow and spend.

The current situation is poised to create terrible pressure on retirees and those close to retirement, because most economists expect inflation to rise again. Inflation is currently low (about 2 per cent), but its average since 1983 is 3 per cent.

Economists know that inflation always comes back to trend and when it does it will be in this context: the online savings accounts, bonus savers and term deposits are yielding in the range of 3 per cent to 4.5 per cent.

So if inflation comes back to its trend of about 3 per cent - when the RBA is still holding the cash rate around there - then the safest forms of saving are not going to produce the income that retirees need.

As I tell people, you can't influence the large cycles such as cash rate, inflation and balance of trade. Therefore, you have to fix what you can fix, and that means finding the highest-yielding cash products with the lowest risk.

WHERE DO YOU START?

The first thing to do is assess whether you are getting expert advice. If you are, have a conversation about this if you haven't done so already. Some advisers only contact their clients twice a year, but my suggestion is that you call your advisers, tell them that you don't want to be caught between rising inflation and a falling cash rate, and schedule an appointment. Be active about this.

If you don't have an adviser, think about getting one. If you're DIY, then you have to start searching for cash products that take you up the return curve while not taking you too far along the risk axis: more yield - not too much risk. Many of you will also require flexibility.

WHAT ARE YOU LOOKING FOR?

If you want the high yields, you will be typically looking at bank term deposits and online savings accounts, which are safe and can earn up to 2.5 per cent above inflation. There are tricks to these.

The online "bonus" savers often pay their high rates for the first four to six months, or they punish you for taking money out in any month, or they punish you for not putting money in.

Term deposits are more straightforward in the rates they pay: the rate is the rate. However, they are inflexible - you have to stash your money for a set period and will lose your high-interest yield if you try to withdraw early. These cash-deposit options may not have the high returns of equity markets, but they are guaranteed by the federal government up to $250,000 if the institution fails. These are the only products that have this feature.

Creeping into this environment are high-yield "hybrid" products, some of which are offering yields of 7 per cent.

They seem to be products of the "cash" variety, but many of them include equity features that expose you to loss.

They may be issued by banks, but they do not contain the word "guaranteed" because it is possible that you'll lose your capital, which doesn't happen with a bank account.

Hybrids generally don't have to pay you interest, the interest doesn't accumulate like a bank account, and the bank can treat the product more like stock.

The problem with these investments that look like cash, but are not really, is that the yields are variable, and there is a risk of losing your capital.

At which point, you are missing out on the main benefit of a "cash" investment: the safety of it.

There are good cash products with high yields in the current market - do your homework and make sure you know what you're investing in.

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