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How to invest as interest rates fall
‘Where to invest now interest rates have fallen’
‘Why property is set to bounce back’
I’m not sure whether you’ve been inundated by headlines like these, but I certainly have. And along with the clickbait headlines come the questions from confused and concerned clients.
As financial advisers, we know why interest rates are important: they determine the cost of capital for businesses, they offer a ‘risk-free’ rate of return from which to compare alternate investment options, and ultimately, they drive cash flow for those with debt. The bigger question, is whether our clients understand them as well?
Education and ‘taking them along for the journey’ is something I see that continues to lag in the financial advice and investment sector today. You only need to look at the popularity of social media platforms and podcasters to understand that the industry isn’t connecting well with the end consumer.
A simple question about how we should be investing as interest rates fall, should be easily answered…..unless your portfolio was poorly positioned before, then you shouldn’t need to be changing your investments based on a single interest rate move. But in the case where portfolios are being managed without the benefit of a separately managed account (SMA), or with reviews as infrequent as annually, then more change is required.
So what changes am I suggesting clients make today?
With the overlay of growing geopolitical risk and volatility, diversification remains my primary focus.
The first thing I’m advising clients to do is to be willing to accept alternative sources of income, and forget about what has and hasn’t worked in the last few years. Think infrastructure, property and those sectors of the market that have lagged in recent years, to ensure they are building resilience into their portfolios.
For those investing in term deposits or holding ‘cash’ because of the interest rates on offer, your income has just fallen by close to 6 per cent, if not more, overnight. It isn’t only important to diversify your income exposure, but also your defensive portfolio. Now is the time to be blending both variable- and fixed-rate bonds within fixed-income portfolios, and stressing the need to invest in one of the most poorly understood asset classes in the market.
This goes without saying, but falling interest rates only increase the importance of investing for growth. Combine the cost of living with increasing longevity, and the case needs to be made for a growing allocation to growth assets, particularly as risk-free sources of income are likely to continue falling in terms of headline rates.
Finally, there is currency, where I’m holding ground, as so many factors converge onto each other. With so many overseas investments, currency will be a key driver of returns for Australian retirees in the next decade; yet the foreign exchange impact is barely considered in portfolios. While it is impossible to predict where the Australian dollar will go from here, it is clear that it must form part of every investment decision. The case for hedging is slowly growing: hedging can protect a portfolio against foreign exchange fluctuations by offsetting currency movement effects on the Australian-dollar value of an overseas investment.
