The subject of interest rates is brought to us via the media on a daily basis. Like it or not, it’s a subject we don’t seem to be able to avoid. At the time of writing, the Reserve Bank had just made it’s announcement about the Official Cash Rate (that it would remain unchanged at 6.5 per cent) and, minutes after Dr Brash had spoken, the news was being flashed to the public of New Zealand and across the globe. Announcements from Alan Greenspan, Dr Brash’s US equivalent, are dissected minutely by most of the world’s news media. These words are arguably some of the most significant spoken by anyone in the world today such is the size and significance of the US economy for the rest of us.
The state of interest rates and, more particularly, their anticipated movement, plays a crucial role in most people’s lives. Interest rate rises affect folk with mortgages, business borrowing or other debt negatively. High or rising interest rates also affect investments in shares and other securities. Share prices tend to fall when interest rates rise since companies pay more for their borrowing and there’s less profit to pay out to share-holders. Lower dividends mean lower valuations for the shares. Higher costs for mortgages mean lower incomes from property investments.
The safe haven when share prices are falling is cash or short term fixed interest securities. Attractive, pre-determined rates for deposits or debentures are a preferred option when interest rates are heading upwards. Capital “flight” to cash is, in itself, a contributor to the share market falling. It’s a self-fulfilling strategy and a trap that many investors fall into – selling when the market is low.
People who rely on term deposits or mortgage funds as their only source of investment return take a contrary view. Since the only element of return is income, investors who rely on term deposits naturally want the rate to be as high as possible for as long as possible – and to be as “safe” as possible. The notion that term deposits are a “safe” option is false. Whilst there’s no disputing that the return might be pre-determined, there are some real risks. One of these is re-investment risk – the problem of finding a home for funds which have matured at a time when interest rates are low. A second is inflation risk. $10,000 invested on term deposit with the interest paid out is going to be worth $10,000 at the end of the term. Okay? Yes, but only if there’s zero inflation. If the term of the investment is five years and the inflation rate is 2.5% per annum, you’ll need $11,314 to be able to buy the same amount of goods or services that $10,000 bought at the outset.
Interest rates need not be a problem. A mixture of investments will ensure that, over times of both rising or falling interest rates, returns can be maintained.
If you have over NZ$350,000 to invest and want truly impartial advice, contact us to find out how we can put your money to work to fund your important goals.
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