Interest rates at record lows! What does this mean for you?

The RBA made history yesterday, cutting interest rates to an all-time low of 2.75%. What does this mean for Australians, and how will it affect their financial situation? LJ Financial takes a look at the economic outlook and the risks and opportunities in this current climate.

In the last 5 years Australia has been referred to as the miracle economy, however the reality is that we are facing a number of serious challenges including the unwinding mining boom (as we know it today), and a continued slowdown in the manufacturing industry sector. In addition to this, the uncertainty out of Canberra, in relation to what Treasurer Wayne Swan will bring to light in the Federal Budget next week means individuals should review their current financial situation.

With historically low interest rates, is now the time to borrow and invest?

Low interest rates are designed to encourage us to borrow more.  However, we are coming off a 20 year credit binge which has resulted in many of the economic problems we are currently facing.  Cheap money is no good unless assets are likely to appreciate in value beyond the investment costs.  There are sufficient risks at present that lend us to a more cautionary approach and suggest the current environment provides an opportunity to accelerate reduction in debt, rather than take on more!

Aren't Low Interest Rates Good for Property?

In relation to the housing market, whilst prices have stabilised, nationwide they still only rose in line with inflation in the 12 months to March 13, and in cities like Melbourne, Brisbane, Adelaide and Canberra – the growth rate was 1.5% or lower – highlighting the struggles the sector is facing, despite record low interest rates.  Don’t forget, Australian residential property is still relatively expensive compared to the rest of the world and we are still highly “geared”.

The Chase for Yield

As a result, we fully expect interest rates to head even lower in the months ahead, which is not good news for savers in cash and term deposits. It will also likely lead more and more people to ‘chase yield’ in bank shares and other companies like Telstra and Woolworths. 

Whilst this is understandable, our fear is that investors are not fully aware of the risks they’re taking in making that trade. With bank shares now more expensive than at any point in history based on certain metrics and dividend yields (circa 5% today on average) below the long term cash rate, chasing yield in these sectors could lead to a narrowly diversified investment portfolio at best, increasing your overall risk.

With credit growth in housing, personal loans and business investment stagnant or trending down, we find it hard to see how the banks will be as attractive an investment in the coming decade as they have been in the previous one.

This highlights more than ever the need for investors to spread their capital across a well-diversified portfolio of assets, which can withstand the likely economic shocks and volatility in the years ahead. True diversification across key asset classes will ensure that when some portions your portfolio are underperforming, other sectors will assist in mitigating your potential losses.

Despite a potentially rocky economic future, there are always opportunities to maximize your financial position. One major benefit that most Australians should take advantage of is to review their personal debts and mortgages. With interest rates low and likely to fall further, now is the perfect time for individuals to review this area of their finances.

In an uncertain economy, getting advice and implementing a well-structured financial strategy makes sense now more than ever.