Big news this week (other than America voting out the tangerine tyrant). The Reserve Bank of Australia cut the cash rate to a record low of 0.1%.
While it’s not the same rate we get on a home mortgage, it’s still a shedload better than paying 17% like our parents did back in the 90s. With home loans now around 2% , it’s an economic game changer.
I don’t pretend to be an expert on monetary policy (where they set interest rates). Nor am I down with the finer details of cash investments (actually much more complicated than just putting money in the bank).
But what I can do is share some of the effects that the current low-interest-rate setting may have in the real world.
Sharemarkets get lit – Remember parties and nightclubs? Remember drinking cocktails out of teapots in the Cross? Yeah me too. Those hazy days of our youth, pre-Covid.
Well, if the sharemarket was a 20-something girl, it would be pre-drinking Breezers and doing its makeup right now. It’s just getting warmed up, I reckon.
No I don’t have a crystal ball, but the general thinking is that one thing leads to another:
Retirees get risky – People who need income from investments (like retirees) aren’t going to get much from cash investments like term deposits, or fixed income assres like bonds. They will be forced to invest in riskier asset classes like shares (aka equities) to make up the difference. The higher the demand, the higher the price.
Wealth builders get FOMO – Even people who don’t need income (because they are still working) will be attracted to equities, because of FOMO and the potential capital growth (i.e. the value of shares going up). When you see people making money, of course you want to get in on that. Again, more demand equals higher prices.
Businesspeople get bold- Companies that need capital to grow look at the hot sharemarket and think ‘we could totally get a bunch of investors to give us their money’. They offer an ownership stake in their company to the general public by selling shares in it. These ‘Initial Public Offerings’ (aka a ‘sharemarket listing’ or a ‘float’ are how entrepreneurs hope to get rich, and it helps to keep the market growing. Check out the recent IPO for Adore Beauty if you’re interested, because the founder, Kate Morris, is #BossLadyGoals.
Markets get frothy – This positive sentiment swirls around for a while, usually years, until something bad happens and people freak out and then prices drop again. Hello, Correction! Sometimes it’s more than a correction, it’s a crash. But the surprising thing about the correction in March this year, when pandemic panic struck, is that it was short and sharp. After the GFC, it took years for the markets to return to their pre-crash level. This year the ASX 200 started at over 7000, dropped below 5000 and is already back up over 6000.
A lot of water needs to go under the bridge before it hits the heights we saw before COVID. What happens when Jobkeeper and Jobseeker end is anyone’s guess. But regardless of the short- to medium-term movements, it’s likely that people will keep piling into shares as they seek income and growth – both of which can be delivered by the right equity investments.
Rethinking investment priorities?
Does this mean you should drop everything and buy shares? Or should you be paying extra off a mortgage, or investing in property?
I’m obviously not going to tell you the answer to that because a) I don’t even know you and b) it’s illegal to give random people financial advice.
But here are some things to consider:
Look at the cost of borrowing vs returns from investing. At the moment, the cost of borrowing for a home is about 2-3% depending on your bank. So it’s cheap as chips, historically speaking. If there was ever a time to take your foot off the gas, repayment-wise, it would be now.
If you are using that extra money to do something productive with – e.g. buy an investment property or invest in shares – then you want it to deliver more than the 2-3% that your capital is costing to borrow.
Certainly shares, historically speaking, have done that. And they might do it again. To be honest, nobody knows exactly what the markets are going to do in this weird, lower-for-longer post-pandemic world. What I can guarantee is that leaving your money in the bank will give you three-fifths of bugger-all.
For my part, I’m hedging my bets, and keeping some money in shares as well as paying a little bit extra off the mortgage. The latter is mostly because it makes me feel secure. That’s in addition to salary sacrificing extra money to my super fund, because it’s tax effective and I want a comfortable retirement. Some might say this is a lack of focus, I call it diversification.
And if you don’t already have a property and a home loan, don’t panic. It’s likely that rates will stay super low for a few years now (there’s a technical reason related to the RBA’s inflation targeting, but I won’t bore you with the details.) House prices may rise again, because credit is so cheap, but if you save hard or nag your parents to go guarantor (or both), property ownership is still a possibility.
Ultimately, the upshot is this: the RBA has set rates low to stoke the economy. They want you to spend and invest. So you know, maybe think of building wealth as a national duty.