Where should you invest when interest rates are so low?

By David Hancock

November 25 2020
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With the cash rate close to zero, this will have big implications for how you should invest your money to generate the best return. So, what are the options and which asset classes will best enable you to build wealth?

Where should you invest when interest rates are so low?

Cash

Australians have put $100 billion in the bank since the onset of COVID-19. This is unsurprising as people tend to play it safe in times of uncertainty. While this may seem like the least risky option, it’s not a great way to build wealth. Such low interest rates mean that savers aren’t going to see any genuine return. To make your money work for you, you need to look at other options.

Bonds

Bonds are loans to companies or governments at a fixed interest rate return. They are typically linked to interest rates and are designed to provide an income (normally above cash rates), although not necessarily capital growth. Investors will receive an interest payment and the invested amount is typically paid back at the end of the loan term, although if you’re invested into a bond fund, then this happens behind the scenes. So, while they may provide a small income, they’re a less attractive option for investors looking to achieve capital growth and a higher income.

Shares

Shares have a low barrier to entry and can generate both an income as well as capital growth over the long term. Throughout the pandemic, some companies aren’t paying dividends due to financial pressures. The sharemarket can also be volatile and some experts believe it is currently overvalued and hence may drop. That said, there are not too many places to invest into that can produce income and capital growth over the long term, so don’t be surprised if the sharemarkets continue to rise as investors feel more confident about general economic conditions and more money floods in.

For most investors, shares will form part of a long-term strategy as they can often experience volatility in the short to medium term. The 10-year returns for the Vanguard Australian shares index fund is 6.8 per cent pa, and the 10-year return for the Vanguard International shares index fund is 11.74 per cent pa (results include income and capital growth). While there has been plenty of volatility during this period, these returns are significantly higher than cash or bonds.

Property

As an investor, a property purchase can provide you with rental income as well as the potential for capital growth. The rate in which you achieve both is reliant on the location of your purchase and the timing of the specific market you purchase in.

Property has a higher barrier to entry – typically a minimum 10 per cent deposit of the purchase price plus purchase costs. However, with record-low interest rates bringing borrowing costs down, property is an attractive option for investors right now.

When investing in property, you also benefit from being able to borrow to purchase a larger asset, which means you are able to generate growth on the total asset value, not just the amount invested upfront. Let’s say you have $70,000 to invest. If you purchase $70,000 worth of shares and their value increases by 5 per cent per annum, that would equal an increase in value of $3,500 per year. On the other hand, you could purchase an investment property for $500,000 which would require an initial outlay of approximately $70,000 (10 per cent deposit plus purchase costs). Assuming that the property market was to rise by 5 per cent, your equity in the property would increase by $25,000 – hence creating greater wealth.

The other benefit of property is long-term capital growth. Historically, the Australian property market – especially in the capital cities – has achieved stable, consistent growth. While there have been temporary times of decline, growth has been stable over the long term.

Deciding where to invest your money is a personal decision. Talk to your financial adviser about your current financial situation and personal objectives to determine which options are best for you.

By David Hancock, Director, Montara Wealth

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