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Smart Investing
An interest rate glass half full
 November 12, 2007
Robin Bowerman
Self-funded retirees could be excused if they raised a glass to celebrate a successful Melbourne Cup week.
But it would probably have been done quietly; behind closed doors because it wasn’t the horse race they were celebrating but rather the rise in short-term interest rates.
When the Reserve Bank announced its decision to lift cash rates to 6.75% on Wednesday morning most of the media focus was naturally on the negative impact on households with mortgages. And there is no doubting the real stress that this and the previous five interest rate rises is causing people with big household debts.
While the interest rate lift was only 25 basis points or a quarter of one per cent on a $300,000 mortgage that translates to $50 a month. The impact of any small interest is felt much more directly in 2007 simply because the size of the average debt has ballooned out as our property prices – and the mortgages required to buy a new house - have jumped dramatically across the country.
But rising interest rates are not bad news for everyone. Self-funded retires may, if they are following typical financial planning advice, have up to two or three years of their annual income in cash or fixed interest. The cash buffer is typically recommended by financial planners to avoid having to sell down growth assets in falling markets to raise cash to meet living expenses. With the cash reserve retirees have the ability to ride through short-term market volatility.
So in the past six years a key part of a self-funded retiree’s asset allocation has gone from earning 4.25% on 30 day term deposits to a healthier 6.75%. On a $100,000 short-term cash investment that is an extra $200 a month.
So that dark cloud of interest rate rises has a real silver lining for retirees. Not that they are likely to be celebrating too loudly because their younger neighbours may be one of those facing the prospect of downsizing.
The cash rate is of course just one style of fixed interest investment. But rising rates make conservative, defensive fixed interest investment more attractive generally. Now the yield is one reason to invest in fixed interest investments. But risk control is an even more pervasive reason for people other than self-funded retirees to look at how much fixed interest they have in their asset allocation.
The cause of our latest rate rise is that our economy is growing strongly – enough to worry the Reserve Bank that inflation will break out of its target band between 2-3%. But when you look overseas there are numerous signals that make the future for the world economic growth less certain. Whether it is the sub-prime mortgage crisis that has already claimed two CEOs from some of the largest, most-respected financial institutions in the US and combined write offs of $US20 billion with new announcements almost a daily occurrence or an oil price seemingly heading above the $US100 a barrel price. The outlook overseas is a lot stormier and potentially more volatile than on the domestic economic front.
So while retirees might be quietly enjoying the rate rise all investors should be revisiting their asset allocation and looking at the role that fixed interest investments can play in ensuring your risk is at a level is you are comfortable with.
More articles from this edition of CompareShares:
Analysis: BHP/RIO: who wins from takeover battles?
Superannuation: Supercharge your retirement savings
Fundamentals: How to value shares like a company analyst
Resident Trader: How to profit from volatility - part 4
Stock of the week: Engineering stock up 630% in three years
Analyst report: M&A activity likely in utility sector
Markets: Global markets still firing, while US falters
Smart Investing: An interest rate glass half full
Expert Panel (CFDs):Why it's worth sticking to the 2% rule
Top Ten: Top ten share CFDs for the week
Whatever your views, you can discuss this article - or any of Robin's articles - on our message board Your 2 Cents.
Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia and the former managing editor of Shares and Personal Investor magazines. To receive this column by email each week go to http://www.vanguard.com.au/ and register with smart investing.
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