How to navigate interest-rate poverty

Many of our 750,000 pensioners will rely on income from term deposits, which are currently paying nothing by way of returns.

Holy cow. Have you seen how much a term deposit pays these days? No apology for the bolt of bovine astonishment, because many of us forget to pay attention to the world of compounding interest.

There is now no hiding from the fact that fixed deposits in New Zealand currently give savers a big fat zero return. That’s right, zippity-nothing.

The big Aussie banks sit at 2.5 per cent for a range of terms. Pay your tax at 17.5 per cent and it leaves a net rate of 2 per cent. Check out the Consumer Price Index and 1.9 per cent of that is being eaten up by price rises – good old inflation. We are left standing still. Those on higher tax rates are going backwards.

Pensioner pinch

In retirement, things are getting painful. Investing in term deposits means you are protecting the purchasing power of your money and no more.

In stark contrast to this, New Zealand shares shot up over 30 per cent in 2019 (including dividends), the only place you can get a cash return of one tenth of this (3 per cent) is at the Indian multinational, Bank of Baroda (branches in Auckland and Wellington) for a term of four years.

The better-known ASB, Westpac, ANZ, BNZ and Kiwibank are all clumped around 2.5 per cent. Local building societies like the Heretaunga can take a bow for its 3.2 per cent two-year fixed rate.

Kiwis have $185 billion stashed in deposit accounts. Quite a proportion of our 750,000 pensioners will rely almost entirely on term deposit income, so if you are one of those feeling the pain you’re not alone.

Asset price boom worldwide

It’s no surprise that asset prices in shares and property have continued to rise in the last decade. There have been intensely low interest rates all over the world as governments sought to stimulate growth after the Global Financial Crisis of 2008. It’s been a big driver.

When largely risk-free deposits have low returns, it sets a benchmark. Risky assets that are in limited supply (such as property or good profitable companies) keep producing the same cash. The only way their returns can fall into line is for a big swoop of capital gains to occur. Investors start paying more and more for shares or houses, until there’s alignment with the lower cash benchmark plus a risk premium.

It’s likely this next decade will see far more measured capital gains and no relief for depositors.

Traditional monetary policy is largely broken as a tool. Globally, central banks can’t pull the interest rate lever down and stimulate growth – there’s nowhere to go at these levels, or the impact is getting muted.

Fiscal policy is now the lever to generate growth. Tax cuts, higher spending or printing money.

New Zealand’s retirees have been hit by low rates, but the uplift in capital gains is reflected in their house prices. Perversely, their wealth is quite healthy, but they’re cash-poor and suffering.

Interest rate poverty

What do pre-retirees do? Avoid cash. Invest in a range of assets, not just New Zealand shares.

What do new pensioners do? Personally I don’t believe it’s too late for a new retiree to begin a balanced portfolio of shares and bonds, if advice is taken. Given the need to prepare for age 90, money must be invested for the second-bloom (age 80-plus). You will encounter boo-hooing at climbing the risk scale. Banks need to keep retail deposits and are not set up to manage this changed environment of advice. Mostly they’re terrified of the regulatory risk of their staff suggesting this course.

What do older pensioners do?

It’s very difficult for someone to change their thinking and become comfortable with sharemarket volatility if they’ve relied on term deposits until this point.

If you have 10 years of headroom before hitting the age of 80 a segment of money could be squirrelled away. You need to be comfortable that your health is good and longevity is in the family. The risk is the need to liquidate some of these funds unexpectedly, when the markets are down.

There is no magic bullet. Accept eating your capital – it’s supposed to happen. Living off interest is a faded concept. Secondly, feel no guilt at tapping into your house in the second-bloom. Why suffer cash-poverty when everyone, including you, is benefiting from an asset boom under your feet? Downsizing is an option for some, otherwise it’s equity release.

That’s another topic that attracts frowns. Goodness knows why. Any future capital gains in your home will help pay off the interest costs on death. Even if house prices remain stagnant until the day you die, the last 10 years of gains should make the costs guiltfree.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.

What do pre-retirees do? Avoid cash. Keep investing in a range of assets, not just New Zealand shares.