How to invest in a low interest rate world
Falling rates can mean high returns if you know where to invest.
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For the last few years, central banks around the world have been slashing interest rates to new lows to boost slowing economies and keep currency rates competitive.
So how can you adjust your investment plan to make the most of a falling interest rate environment?
Low-interest rates environment: Is it all doom and gloom?
With COVID-19 being one of the biggest challenges the global economy has faced, banks around the world, including the Reserve Bank of Australia (RBA), have been forced to cut rates to near zero.
This means that every day Australians with money in the bank are struggling to find a decent return on their savings. But fret not, falling interest rates can actually be beneficial for investors.
In fact, many types of investments perform better when interest rates go down or when the economy underperforms. And you have the potential to get far bigger returns than you would from the bank, you just need to be willing to take on a higher level of risk and do your homework.
Risk vs reward
Before we look at investment ideas, there's an important warning to get out of the way first – investments that offer the potential for returns above and beyond current interest rate levels usually come with a higher level of risk. That's a simple fact that you need to wrap your head around before you think about moving money out of the bank.
The key to managing this risk is to not put all your eggs in one basket. By diversifying your investments across a range of asset classes, you can avoid taking on an unacceptable level of risk with any one investment.
How do low rates impact investment markets?
While there's always debate about what impact an interest rate decision will have on the economy, there are a few investment themes that we've come to expect will occur in Australia when rates are low:
- Stock market rises. Shares become a more lucrative investment as bank products see returns dwindle and consumer spending increases.
- Australian dollar falls. Lower rates usually pull down on local currency as foreign investment becomes less attractive.
- Bond market to rally. When interest rates fall, bond prices rise and vice versa.
- The export sector wins. A lower dollar makes Australian goods more competitive on global markets. Conversely, the imports sector will find it harder to make profits.
- Domestic spending increases. Lower rates should encourage households to save less and spend more, however, this could be tempered by flat wages.
- Dividend stocks are more attractive. As capital returns become harder to chase, dividend paying stocks become more popular.
- Bank stocks might fall. Low rate environments can make it a challenge for banks to maintain profit margins.
- Real asset stocks rise. Real assets such as property and utilities stocks are expected to become more attractive for investors.
The 10-year inverse relationship between the RBA cash rate and the ASX200
Source: ASX, RBA
Shares are one of the first options that investors turn to when interest rates plummet. Low interest rates tend to be good news for growth assets such as shares, as interest payments are often a major cost for businesses. Lower rates therefore mean increased profits for businesses and rising share prices.
Stock markets also tend to do well because investors believe the rate cut will encourage more spending and borrowing in the economy. In other words, rate cuts encourage optimistic buying.
Of course, picking the right shares to buy and sell is often easier said than done. If you want shares that can provide capital growth, you may need to look beyond the large-cap stocks on the ASX. Alternatively, shares can also provide an ongoing source of income through dividends, so you also have the option of investing in companies with a history of paying solid dividends to shareholders.
Just remember that share prices fluctuate all the time – they could increase and lead to a tidy profit, or they could decline and you could lose some or all of your money – and there is no guarantee that a company will pay dividends.
Top stocks for low rates
- Dividend stocks
- Gold stocks
- Infrastructure stocks
- Utilities stocks
- Property stocks
Compare share trading accounts
Important: Share trading can be financially risky and the value of your investment can go down as well as up. Standard brokerage is the cost to purchase $1,000 or less of equities without any qualifications or special eligibility. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
The value of your investments can fall as well as rise, and you may get back less than you invested. Past performance is no indication of future results.
Invest in ETFs and index funds
Exchange traded funds (ETFs) are investment funds that are listed on the stock market, and investors buy and sell units in these funds in the same way that they trade shares. Each ETF contains a portfolio of assets (for example, shares, commodities and bonds) and many are designed to track a specific market index – called index funds.
What is a market index?An index normally tracks a specific collection of stocks or commodity prices. It acts as a performance indicator for the markets. Australia's most well-known index is the ASX200, which consists of Australia's biggest 200 companies.
ETFs have become popular because many offer a low-cost and simple way to invest in specific markets, industries or commodities. For example, if you think gold prices are due to increase, you can invest in an ETF that tracks the price of gold. If you’ve got a feeling that the ASX is set to boom, invest in an ETF that tracks the ASX200.
By tracking an index rather than buying and selling shares in individual companies, ETFs can take some of the guesswork out of investing and keep fees low. Many funds aim to perform at the same level as the broader stock market, although some achieve returns well above that. Below is a list of the best performing exchange traded products on the ASX in the 2018/2019 financial year.
|Code||Type||Fund Name||1-Year Total Return|
|ETPMPD||Commodity||ETFS Physical Palladium||68.38%|
|MVA||Australian Property||VanEck Vectors Australian Property ETF||27.26%|
|ETPMPM||Commodity||ETFS Precious Metals Basket||24.07%|
|GDX||Global Equity - Sectors||VanEck Vectors Gold Miners ETF||23.74%|
|GLIN||Equity - Infrastructure||AMP Capital Global Infrastructure Securities Fund (Unhedged) (Managed Fund)||21.99%|
|VAP||Australian Property||Vanguard Australian Property Securities Index ETF||19.44%|
|PMGOLD||Commodity||Perth Mint Gold||19.35%|
|SLF||Australian Property||SPDR S&P/ASX 200 Listed Property Fund||18.93%|
|GOLD||Commodity||ETFS Physical Gold||18.71%|
|RINC||Australian Property||BetaShares Legg Mason Real Income Fund (Managed Fund)||17.96%|
Note: It's important to understand that not all ETFs are passive index funds and some are riskier than others. For more about ETF investing and the risks involved, you can read our comprehensive ETF guide.
Peer-to-peer (P2P) lending funds offer an alternative investment opportunity that is growing in popularity in Australia thanks to the competitive returns.
When you invest in a P2P, you're essentially playing the role of a bank. In other words, you lend your money to one or several borrowers through a third-party lending website, which you're then paid back at an agreed rate of interest within a set timeframe. This allows you to enjoy a higher rate of return than you could get from having money in the bank.
As the lender, you get to choose how much money you wish to lend and at what interest rate. The lending platform then matches you up with borrowers in need of funds. These types of loans are usually offered as car loans, business loans, personal loans or for debt consolidation.
P2P investing platforms
Disclaimer: Investments made through a P2P lending platform are not protected and are subject to risks including credit risk (defaults) and liquidity risk. These investments are not subject to review by the Australian Financial Complaints Authority. Actual returns may vary from the Expected Returns declared by the Providers. Read the PDS for details before investing and consider your own circumstances, or get advice, before investing.
It's important to understand that not all P2Ps offer the same level of security. While some advertise interest rates upwards of 20%, you may also risk losing your investment if the borrower defaults on the loan. Also, make sure you do your homework before investing.
Invest in property
Like shares, property is another sector that investors turn to when interest rates drop. When interest rates are lower, owning property should become cheaper and more attractive.
An investment property can not only provide capital growth as housing prices rise, but also an ongoing income through the rent you receive. Of course, you’ll need to deal with risks such as buying at the right time, dealing with problem tenants, finding a property manager and coping with market downturns.
Another option worth considering is listed real estate investment trusts (REITs) and property stocks. These give individual investors access to property assets that may otherwise be beyond their reach, such as large commercial properties, apartment buildings and hotels.
REITs are an easy way to diversify your portfolio and they provide an income stream as well as capital growth, with the potential for returns well above current interest rates. However, you do need to be aware of risks such as falling markets and the fact that past income distributions do not indicate future distributions.
REITs listed on the ASX
Corporate and government bonds
The bond market usually performs better when interest rates drop and the stock market becomes more volatile. This is because bonds are considered to be one of of the most secure investment options available in the market.
When you invest in bonds, you're loaning money to the government or a company for a set period of time, similar to a term deposit. In return, the organisation pays you back at a fixed rate for the length of the term.
While you can’t usually expect the same high returns by investing in bonds as you would get from shares, you can expect a lot more security – although this isn't always the case. Government bonds are usually classified as the safest, while corporate bonds vary depending on their credit ratings.
As money pours into the bond market and prices rise and yields drop, investors are indicating that they prefer the safety of bonds, even as return on investment drops.
Because central banks have indicated that the target cash rate is likely to stay low for some years, global bond prices soared in 2018/2019 financial year, sending yields to new record lows.
You typically need a large sum of money to invest directly in bonds, with minimum investments upwards of $250,000. But in more recent years, it's become possible to invest in bonds via the stock exchange with as a little as a few hundred dollars in products such as bond exchange traded funds (ETFs) and exchange traded bonds.
Invest in gold
When interest rates fall, it's usually a sign from the central bank that the economy is underperforming, which is historically a boon for the gold market.
This is because gold is regarded as a stable investment that is less volatile than regular stock or forex markets, so people often turn to the precious metal as a way to protect their wealth. Although not truly inverse, it means that gold prices typically go up in a falling cash rate environment, as you can see in the chart below.
Gold prices and the cash rate
There are a few ways that you can benefit from the rising gold price. You can buy physical gold from a bullion dealer, invest in gold stocks or invest in a gold fund, such as an ETF. Below is a list of gold-themed ETFs listed on the ASX that are worth considering.
- VanEck Vectors Gold Miners ETF (ASX: GDX)
- BetaShares Global Gold Miners ETF - Currency Hedged (ASX: MNRS)
- ETFS Physical Gold (ASX: GOLD)
- Perth Mint Gold (ASX: PMGOLD)
- BetaShares Gold Bullion ETF – AU Hedged (ASX: QAU)
But if you want to buy gold bullion or invest in gold through the stock market, you can read our extensive gold guide.
Infrastructure and utilities
When interest rates are low, seasoned investors commonly shift more funds into real assets, such as property and utilities stocks. At the same time, it pays to be cautious of financials stocks – since profit margins among lenders drop when rates are low – as well as the riskier growth stocks.
Ports, rail, airports, toll roads, utilities, telecommunications, schools and hospitals are always in need, no matter what level interest rates are at.
This means that investing in infrastructure provides the potential for solid returns; plus, it also allows you to diversify your portfolio. Popular examples include Auckland Airport (AIA), Transurban Group (TCL) and the telecommunications sector.
Top tips for investing in a low interest rate world
There’s plenty more you can do to improve your financial position and maximise investment returns in a low interest rate environment. Make sure to:
- Pay off your debt. When interest rates are low, use the extra capital to pay off your existing debt, such as your mortgage. You can use this time to make extra mortgage repayments and increase the equity in your property, which can act as a helpful safety net against future rate rises.
- Diversify your investments. Don’t put all your eggs in one basket. Spread the money around so if a specific industry or asset class takes a dive, your entire portfolio doesn’t go down with it.
- Know how much risk you can tolerate. Any investment other than a conventional bank deposit attracts a higher level of risk, so make sure you know just how much risk you’re willing to take on before you invest anywhere.
- Maximise your savings. If you have money in a savings account, it’s important to review your account regularly when rates drop and shop around for the best savings interest rate available.
- Stay flexible. Interest rates are going to increase again at some point in the future, so make sure you understand the implications of locking your funds away in a long-term investment such as a five-year term deposit or bond.
- Understand your investments. Don't simply follow the crowd. It’s important to understand an investment before putting any money towards it. If you don’t know what you’re getting yourself into, that’s a surefire recipe for disaster. Don’t hesitate to seek professional advice whenever necessary.
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In a world where the official cash rate is heading towards zero, you could still make your money work harder for you by using these strategies. If you're keen, start comparing.
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