What the interest rate cut means for your investments

So what does this mean for investors, savers and property owners?

The RBA has cut interest rates for the second month in a row to a record low 1%. Weak economic growth and inflation, falling house prices and weak employment numbers all contributed to the move.

For the regular person trying to get their head around what the cuts actually mean it can be difficult to understand if you need to be worried or not and what you need to do. After all, interest rates and the economy are complex beasts.

Broadly speaking when a country cuts its interest rates the goal is to spur on economic activity, hiring and investment. Central banks do it when the economy isn’t firing. If you’re not watching you could be caught out by some serious knock on effects.

So what does this mean for investors, savers and property owners? Who are the winners and losers? Does it even matter?

Here’s how the cuts will impact your back pocket.

The winners

Investors in Australian shares and bonds

Investors in Australian shares and high grade bonds are usually the early beneficiaries of an interest rate cut. Australian shares are already up 15% this year and bonds up by 5%. Some of this reflects investors getting in ahead of the move.

Shares typically rise because lower rates lead to consumers and businesses increasing spending and investment. Lower interest rates also make share dividend yields and fixed bond coupons more attractive compared to leaving your money in the bank.

An interest rate cut means the cost of borrowed money goes down. What does this mean? Businesses can borrow at a cheaper rate and they can invest more in their business. Consumers with loans and mortgages can now pay the interest more easily and have more income left over to spend.

Now you might be thinking ‘this isn’t me, I haven’t borrowed any money’. However, that doesn’t mean your neighbour hasn’t or your kids teacher. If they’ve suddenly got more money and choose to spend it on goods and services they’ll help spur on the economy.

Rather than spend, these same people can also choose to save their extra money or pay off more of their mortgage. Given the high indebtedness of Australian mortgage holders, Aussies might use the cut as an opportunity to boost their savings rate and pay down their mortgage debt. If this happens the economy might not see much of a jolt.

What should investors do?

If you are investing make sure your strategy suits your financial goals and willingness to ride out short term ups and downs in markets. We recommend clients combine different investments like shares and bonds to reduce risk.

This strategy of spreading your money across different unrelated investments won the 1990 Nobel Prize in Economics. Don’t forget the market is smart and some of the rate cut has probably been baked into prices already!

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The losers

Savers in savings accounts and term deposits

The biggest losers will be people who leave all their money in cash savings accounts and term deposits (TDs). Banks will be swift to cut the cash rates on offer. Already eye wateringly low, savers can expect even lower interests on savings accounts. That 2.8% you get on your ING Savings Maximiser or UBank USaver is almost certainly set to fall as they have been since 2010.

Leaving all your money in cash savings or a TD means your money is actually going backwards compared to the prices of goods and services: if you earn 1.25% interest from your bank (a typical standard variable rate today) and the inflation rate is 1.75%, the real rate of return on your money is actually negative 0.5%. This means you’re pedaling backwards every year. And that’s even before taxes on your interest earned.

What should savers do?

We tell all clients to keep some money in cash savings for short term expenses. But for money you don’t need in the short term, savers should consider investing. Exchange Traded Funds (ETFs) offer great diversification and low fees for longer term investors. They’re lower risk and lower stress than buying shares in a few companies.

The inbetweeners

Homeowners and investment property owners

A rate cut is usually great news for property owners. Lower interest and higher borrowing capacity work together to lift prices. Unfortunately for homeowners and property investors it’s unlikely this rate cut will do much to lift property prices back to where they were in 2017.

Property rental yields are still at all-time lows and despite some price falls, residential property in most cities remains unattractive as a ‘growth’ asset. This is compounded with the extra supply of new apartments about to drop onto the market in the capital cities and increased scrutiny lenders are placing on borrowers.

It’s a perfect storm for prices; increased supply of houses and apartments, falling demand from borrowers and reduced availability of lending from banks. Weakness in house prices was at least partially why the RBA cut.

The property market will need more than a rate cut to reverse the negative momentum in prices. Any temporary uplift is likely to be met with new sellers.

What should property owners and property investors do?

The best course of action for property investors is to shop around and avoid the lazy person tax and find the best mortgage interest rate possible. The Founder of Uno Home Loans recently announced a comparison rate of 3.39% p.a. which is surely one of Australia’s lowest ever.

If you have a high amount of mortgage debt, use the lower rate as a chance to pay off more of your principal. Don’t expect a quick or sharp reversal in prices.

Those with most of their money tied up in property but low debt may want to consider diversifying into other investments. An investment portfolio of just Australian residential property is a high-risk strategy because you’re concentrated in a single asset class.

You might be better off spreading your money across a mix of different investments to reduce the risks to your personal wealth if there’s a prolonged fall in property prices.

Founder and CEO

Chris has been vocal in calling out the industry 'Fat Cats' and is known for telling it as it is. He sits on two Advisory Committees for the industry regulator ASIC, and was previously a fund manager at UBS. He holds a Bachelor of Commerce (Accounting/Finance Co-op Scholarship) from UNSW.

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