How do interest rates affect me?

Low interest rates have been a constant in the Australian economy for so long that it can be difficult to remember what life was like when they were as high as 17 per cent, a quarter of a century ago.

Just imagine what such rates would do to a mortgage holder in today’s property market! On the flip side, imagine what a boon it would be for retirees who depend on investment income for daily living expenses.

So why have they been so low for so long?
Of course, economic conditions in the ‘80s and ‘90s were very different to what they are today. Back then, inflation was rampant, and interest rates were the big stick that policymakers used to try and bring it into line.

Times have changed. Inflation is no longer the scourge that it used to be: low interest rates are now being used to stimulate consumer and business activity around the world. Another major factor driving the Reserve Bank to maintain low rates is that it lowers the attraction of our currency to foreign capital, which in turn helps to lower the exchange rate. A lower Aussie dollar makes our exports cheaper for the world to buy, thus stimulating economic growth domestically.

Effects on your financial planning
At a personal level, low interest rates may seem like a limiting factor in your financial planning. However, by making strategic decisions, you can create opportunities to improve your financial position, grow your investment portfolio, and boost your investment income.

For those who still have a mortgage or other significant debts, paying down that debt faster in times of low interest rates may be an option worth considering — depending on your other circumstances and investment situation.

There is also a school of thought that says low interest rates are actually an opportunity to take on debt for the purpose of investing in growth investments, such as property or shares. While this may suit some, it can involve significant risks, so expert advice should be sought to closely examine your situation and objectives before engaging in debt-funded investments.

Thinking outside the square
Diversifying your investment beyond predictable savings accounts or term deposits may also be worth considering. This may cause increased volatility in your portfolio, but it is a matter of balancing the potential for growth and higher income against this risk.

Another important consideration is whether you need to drawdown income from your investments in the short term. Generally speaking, if you are relying on drawing an income in the immediate term, part of your portfolio should be in asset classes that are less volatile — but that doesn’t mean that you can't diversify your investment funds so that some is allocated to growth investments such as shares, property, and managed funds.

Shares can deliver income stream
While shares are exposed to market fluctuations, there are certain types of shares that may be worth considering if an income stream is one of your objectives. These are known as "high yield" stocks, which are usually large, well-established businesses that have a track record of paying consistent dividends.

Using such shares as part of an income stream strategy also gives you the advantage of tax imputation credits — which make them even more attractive — as well as the benefit of potential capital growth.

As an alternative to investing in such shares directly, you can access them via a managed share fund which specialises in that sector of the market and gives you the benefits of a having a spread of shares without all the hassle of managing the investment yourself.

Putting your strategy together
If you are concerned about the restrictions of low interest rates on your investment or your retirement income, and you want to consider the alternatives, it may be wise to consult a financial planner. They can help assess and recommend strategies that are appropriate to your "risk profile" and can target the right balance of capital growth, capital security, and income generation.

It always helps to get independent advice, so that you can make informed decisions and objectively weigh up the pros and cons, based on solid research and expertise.

Do low interest rates concern you? Share your thoughts below.

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