Low rates don’t have to stop you from enjoying high investment returns.
When the Reserve Bank of Australia (RBA) cut the official cash rate by 0.25% in August 2016, interest rates reached an all-time low of 1.50%. This was bad news for anyone with a savings account, as the interest-earning capacity of everyday Australians took another sizeable hit.
But just because rates have hit rock bottom doesn’t mean you can’t find investments that offer a high rate of return. There are several investment options that can potentially provide a return well above what you could expect from a savings account in the current climate, you just need to be willing to accept an increased level of risk.
Risk vs reward
Before we take a look at some promising investment ideas for the present low-interest-rate environment, there’s an important warning to get out of the way: investments that offer the potential for returns above and beyond current interest rate levels come with a higher level of risk. That’s a simple fact you need to wrap your head around before you even think about looking past the humble savings account for better returns.
The key to managing this risk is not putting all your eggs in one basket. By diversifying your investments across a range of asset classes, you can prevent exposing yourself to an unacceptable level of risk with any one investment.
Shares are one of the first options 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, so there’s money to be made by investors if you know where to look.
Of course, picking the right shares to buy and sell is often far 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. However, 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.
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Exchange traded funds (ETFs) are one of the fastest growing investment products in Australia and around the world. ETFs are investment funds that are listed on the ASX, with investors able to buy and sell units in these funds in the same way they trade shares. Each ETF contains a diversified portfolio of assets (for example shares, commodities and bonds) and is designed to track a specific index.
ETFs provide a low-cost and simple way to invest in specific markets or industries. 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. However, like any other investment they do come with risks attached, and the value of an ETF will rise and fall in line with the index it tracks.
Another way to increase your returns is to look to online marketplaces that offer new and alternative investment opportunities. One such option that’s experiencing a growth in popularity in Australia is peer-to-peer lending.
Peer-to-peer lending allows investors to play the role of a bank. In other words, you can lend your money to a borrower through a third-party lending website. The borrower then pays back the money at an agreed rate of interest and within a predetermined timeframe, allowing you to enjoy a much higher rate of return than you could get from a savings account.
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 a borrower in need of funds. These types of loans are usually offered as car loans or for debt consolidation.
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Like shares, property is another sector that investors turn to when interest rates drop. With rates at 1.50%, it’s as cheap as it’s ever been to take out a loan to purchase an investment property.
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). These give individual investors access to property assets that may otherwise be beyond their reach, such as large commercial properties.
REITs offer 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.
Corporate bonds offer a way for you to indirectly lend money to a company, with the company making interest payments to provide a return on your investment. This allows the company to raise the funds it needs to finance its activities and provides a secure and guaranteed return on the money you lend.
Bonds are classified as a relatively low-risk investment opportunity but they still attract higher interest rates than savings accounts and term deposits. This is in part because they are long-term lending structures, but also because there is a risk that the company will be unable to pay the money it borrows.
You should also be aware that you will typically need a large amount of money to invest in corporate bonds.
One final option worth considering in a low-interest-rate environment is investing in infrastructure. 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. The best way to gain exposure to infrastructure assets is through managed funds. However, current levels of high demand mean that infrastructure assets are more expensive at the moment than they have been in the past.
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. Low interest rates make now a great time 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. Wherever you choose to invest your money, don’t put all your eggs in one basket. Spread the money around so if one particular 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 accept before you invest anywhere.
- Maximise your savings. Keeping some money in a term deposit or savings account will always provide guaranteed, safe returns. But in a low-rate environment, it’s important to review your account regularly and shop around for the best interest rate available.
- Stay flexible. Interest rates are going to increase again at some point in the future, so be wary of locking your funds away in a long-term investment such as a five-year term deposit.
- Understand your investments. 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.
- Be careful if you borrow to invest. Some may be tempted to take advantage of low interest rates and borrow money to invest. However, be warned that while this can help to amplify your gains, it can also get you into an even deeper financial hole if the market heads south.