posted in: Building Wealth
Where do I put my money when interest rates are at all-time lows?
Interest rates and bond markets
Interest rates across the country have reached historic lows as the Reserve Bank of Australia has cut the official cash rate to 0.25%, with the potential to fall even lower. Bonds returns are also at all time historic lows according to the AFR. The income return on Australian 10-year bonds has dropped from 1.3 per cent per annum at the beginning of the year, to 0.93 per cent at present.
A bond is simply a loan to a company or government at a fixed interest rate return, for an agreed amount of time. Your investment in a bond means you’ll receive an interest payment and the invested amount is typically paid back to you at the end of the term. Much like investing in cash (term deposits) a bond investment strategy is aimed at providing income, not capital growth.
With cash and bond returns at all-time lows, this begs the question – where should you put your money to get a genuine return?
Attractiveness of shares
Shares are a good option if you are looking for an asset class that has low barriers to entry that can generate an income as well as capital growth over the long term. Due to the nature of Covid19 and its varying impacts on different industries across the globe there could be short term risk for dividends as a lot of companies won’t be paying these at the same level as last year due to bad debts, easing government stimulus and the need to build up capital reserves.
When purchasing shares, you want to invest in companies where profits are going to increase over time, therefore making your share in the company more valuable. Some experts believe the share market is currently overvalued as investors with limited options are chasing a genuine return, potentially inflating the value of share markets as more and more money floods in.
If not shares, then where else can you generate a return?
With the sharemarket looking potentially more attractive than it is, where else can you put your money? Property is an asset class that may be overlooked due to the higher barrier to entry, typically a minimum 10% deposit of the purchase price plus purchase costs.
But for those investors with the means to access property, there are two key benefits that you can take advantage of.
- Leverage (borrowing)
One is your ability to leverage against property. Typically, banks are more comfortable lending against a property and therefore will allow you to purchase properties where you’re borrowing a significant portion of the value. For example, using a 10% deposit to purchase a property would mean you’ve borrowed 90%. This is important for an investor as you’ve increased your asset base dramatically which will allow you to generate growth on the total property value, not just the initial amount you have invested.
Someone purchasing an investment property for $500,000 would require an initial outlay of approximately $70,000 (10% deposit plus purchase costs). Whilst property prices can move up and down, the long term capital growth sits around 5-6% per annum. Assuming that the property market was to rise by 5%, your equity in the property would increase by $25,000. On the other hand, if an investor purchased $70,000 worth of shares (the same initial outlay as the property) a 5% increase in capital growth would equal an increase of $3,500. This is because the property investor in this example, is getting capital growth on the total value of the property ($500,000) not just the initial investment ($70,000).
- Long term capital growth
The second benefit correlates to the first point and is largely the reason why banks are so willing to lend at such a high rate. Historically, the Australian property market and more specifically the capital city markets have achieved stable, consistent growth. The below graph showing the long-term performance of each capital city market.
The graph above, clearly shows the significant and steady increase that property prices across Sydney, Melbourne and Brisbane have experienced between 1970 and 2020. Whilst there have been times of decline, these are temporary when you consider the stability of property prices over the long term.
Despite dealing with multiple changes to the world’s economic landscape, Australian political and regulatory changes, Australia’s consistent population growth has under-pinned property demand and ensured that property prices continued to rise. Whilst international migration is currently on pause, this is being countered by a large return of expats and a tightening of supply in many of the property markets across Australia.
As an investor, a property purchase can provide you with a stable rental income and 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.
Currently investors are benefitting from historically low interest rates reducing repayment amounts. According to the Head of Research for Binnari Property, Dominic Cavagnino “many investors in the current market, are finding that the income on their properties is covering the majority if not all of their expenses. Once you consider tax deductions, most investors are finding themselves with a cash flow positive investment.” Essentially a key driver for property investment is your ability to hold onto a property with minimal to no holding costs, while also having the potential to achieve strong capital gains.
Deciding where to invest your money is a personal decision. It is important to have an investment strategy in place that considers your personal objectives. Deciding which asset classes are best for you will vary depending on your current financial situation and your investment timeframe. As with all investing, there is risk attached, so we recommend you speak to your advisor about which asset classes are best for you. If you have any questions around building a financial strategy, or working out which investment pathway is best for your personal situation, feel free to get in touch with one of our financial advisors by clicking here.