The federal government uses deeming to work out what the income created from the financial assets of a set of taxpayers would be. It is a broad figure and assumes assets earn a set rate of income, irrespective of actual earnings.
Treasurer Josh Frydenberg has announced cuts to the deeming rates for large investments from 3.25 per cent to 3 per cent and 1.75 per cent to 1 per cent for smaller investors. These will be backdated to 1 July.
In effect, this means the government will be assuming earnings are lower than what they are currently, which lowers the expected and means tested income of a taxpayer.
Is it enough?
Speaking with Nest Egg, senior vice president and chief investment officer for La Trobe Financial, Chris Andrews, believes the changing in deeming rates do not go far enough as the cash rate continues to fall.
“The changing deeming rates is an interesting one. It’s certainly well and truly overdue; the old deeming rates were wildly inappropriate and arguably the new proposed deeming rates are still not quite as generous as they should be for investors,” said Mr Andrews.
Finding the floor
Deeming is designed to be the floor for risk-free investments, and for Mr Andrews, the latest cut doesn’t go far enough in achieving this.
“If the deeming rate is meant to be equivalent to the risk-free return or nearly to risk-free return, it’s hard to justify at 3 per cent. What are investors really getting for their cash? They are getting more like 2 if they have it deployed efficiently, and so that’s a real net cost for pensioners,” said Mr Andrews.
“If I look at the yield report best term deposit rate, you don’t get a 3 per cent return until you’re out at five years,” continued Mr Andrews.
Old school favourites
Mr Andrews believes that if investors are getting less than the deeming rate as a return on investment, they are not investing adequately.
“Our advice always to investors is if you’re caught up by deeming rate, what it means is you are not deploying your funds, your investable cash, your nest egg as efficiently and effective as you should, and there’s a cost of that in your investor portfolio,” said Mr Andrews.
According to Mr Andrews, many of the traditional investor favourite strategies – which are often centred on deeming considerations – are facing headwinds in the current environment. For example:
Cash: Mr Andrews believes that a current cash-based strategy does not provide a high enough yield for investors. “The hunt for yield is going to continue; they need to look at alternative sources for income.”
This has been reaffirmed by Canstar’s financial expert, Steve Mickenbecker, who stated: “NZ cut the base rate on its Online Saver by 0.15 [of a percentage point] to a new rate of 0.15 per cent, while NAB has cut the base rate on its iSaver account by 0.19 [of a percentage point] to a low of 0.11 per cent. The base rate is all that is left after the three, four or five-month introductory promo rate expires.”
Bonds: “When it comes to bonds, you’re running interest rate risk and the same yield compression issues with term deposits,” said Mr Andrews.
The current trading price for an Australian 10-year bond is just 1.412 per cent yield as the central bank rates fall to 1 per cent.
Hybrids: While hybrid securities might provide the financial return investors are looking for, it provides a leave of complexity that is hard for the average investor.
“If you think about bonds and hybrids, hybrids for retail investors, for my mind, they are complex financial structures and I do query whether investors should be investing in those unadvised,” continued Mr Andrews.
Annuities: “Again, affected by exceptionally low interest rates, annuities in this day and age are very difficult to justify given the low effective returns,” said Mr Andrews.
ASIC has previously stated that one of the main drawbacks to annuities is over the long term an annuity may pay less than a market-linked investment.
Cameron Micallef is a journalist at Nest Egg, writing primarily about personal wealth and economic markets.
Prior to this, Cameron worked for Australian Associated Press. He graduated from the University of Wollongong with a double degree in communications and commerce.