How retirees can keep the good cash times rolling
It is a great time for retirees holding cash investments. With rate cuts ahead, here’s what they can do to maintain higher returns.
It is a great time for retirees holding cash investments. Some high interest bank accounts are paying more than 5 per cent interest while private credit investment funds are paying up to 10 per cent interest. We have to go back to 2008 to find a period when cash was paying so well.
But just like the 1970 George Harrison song All Things Must Pass, there will be a time when we have to say goodbye to these healthy interest rates, and that time may just be around the corner.
Although Reserve Bank governor Michele Bullock is not in a rush to reduce the official cash rate from the current 4.35 per cent setting, futures markets have even money odds that we will see a rate cut by Christmas. And beyond that, the consensus from economists is that we will see multiple rate cuts into 2025 as inflation falls back within the 2 to 3 per cent RBA target band.
Sharemarkets are predicting four interest rate drops over the next 12 months and big banks are in agreement, recently cutting interest rates on their fixed rate mortgages. For deposit holders, bank term deposit rates are hovering around 4 per cent for 12 months and 3.5 per cent for 60 months.
If inflation falls to 2.5 per cent by 2026 as the RBA forecasts, the problem with a 3.5 per cent yielding term deposit is that the real rate of return is only 1 per cent. And if tax is paid on the interest, the net return after inflation and tax could end up being negative.
Looking at some of the options to try to maintain higher cash returns, fund manager Pengana recently released a product named TermPlus. Investors can choose to lock their money for one, two or five-year periods with different interest rates offered.
Currently the one-year account pays 7.35 per cent interest (RBA cash rate plus 3 per cent), 8 per cent for two years (RBA plus 3.65 per cent) and 8.5 per cent for five years (RBA plus 4.15 per cent). Pengana makes it clear, though, it is not a bank and it is not offering a term deposit.
The interest rate is variable meaning that as the RBA cash rate drops, so will the interest on the TermPlus account. In other words, it is not the interest rate that is fixed for the term, it is the money invested in the account that is locked away for the term. TermPlus is not covered by the federal government’s $250,000 guarantee on deposits and investors can expect one to two years of negative returns over a 20-year period.
When you invest in the TermPlus account, your money gets invested in the Pengana private credit feeder fund, which then gets invested in the Pengana private credit master fund, both domiciled in the Cayman Islands. With the assistance of Mercer, this fund invests in a wide variety of global private credit investments including more than 2000 individual loans comprising both senior debt and mezzanine finance investments.
Pengana Capital Group chief executive Russel Pillemer says: “TermPlus unlocks the world of global private credit to deliver highly attractive target rates for all Aussies.
“TermPlus is a long-overdue offering for Australian savers looking for great target rates from their online term accounts.”
And if things go wrong, there are three layers of protection that can kick in to reduce the chance of the investor exiting after the term with less than what they started with, although understanding the exact mechanics of how this works in practice may be a little difficult for the average retiree to get their head around.
A simpler alternative to lock in high interest rates is a term annuity.
Challenger, the largest annuity provider in the country, has five-year fixed term annuities currently offering 4.55 per cent interest paid annually. Operating similar to a term deposit, the money is locked away for the term and at the end, 100 per cent of the investment is returned to the investor.
The major difference is that the Challenger term annuity is not covered by the federal government’s $250,000 guarantee on deposits. It is instead guaranteed by the ASX-listed Challenger that currently has an “A” credit rating.
Another option is to use an exchange-traded fund that invests in government bonds. Betashares has an Australian government bond ETF (ASX: AGVT) that holds a portfolio of federal and state bonds with an average maturity of nine years. This is good for those who want to lock in government bond rates for longer periods of time.
Although the yield on the bond portfolio is only a little over 3 per cent, the ETF has a modified duration of 7.63 years. What this means in simple terms is that for every 1 per cent drop in the cash rate, the ETF would be expected to increase by 7.63 per cent in value. And with the expectation that rate drops are on the horizon, this ETF has already increased by almost 5 per cent in value since July.
With 3.5 per cent interest locked in for five years using a government-guaranteed bank term deposit being the benchmark for cash investors, those seeking even higher returns will need to research and assess the various options carefully as each have their own unique pros and cons.
The best advice is to only invest after you fully understand what you are getting yourself into. As Warren Buffett once said: “Risk comes from not knowing what you’re doing.”
James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au
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