How do lower interest rates help you make good financial investments?

Lower interest rates have been a welcome fixture in the economy recently, but if you haven’t been taking advantage of the opportunities they create here are some possibilities to consider.

Remember what was happening in the year 1990? Nelson Mandela was released from prison, Margaret Thatcher resigned as Prime Minister, The Simpsons and Seinfeld were in their infancy as TV programs. While all that was happening, interest rates in Australia hit a high of 17.5%. They were scary days indeed! Many of us may remember what it was like trying to pay our mortgage during those tumultuous times and it’s a far cry from the prolonged run of low interest we have had recently.

Of course, low interest rates are a double edged sword. While those paying mortgages may see it as a welcome boon, those relying on fixed rate investments may have their incomes severely restricted. No matter what side of the ledger you are on, however, there are opportunities created by low interest rates that are worth considering.

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Consider both the emotional and rational aspects when making financial decision

Is reducing your debt the best approach?
One strategy for those who have mortgages or other debts is to consider increasing repayments to pay down the debt faster while interest rates are low. This may well be a wise approach for some, but there is no one-size-fits-all answer. It really depends on your individual goals and circumstances. If you are looking to expand your investment scope and seek growth opportunities, it may well be more advantageous to direct discretionary funds into other investments, rather than paying down debt.

When making such judgements, there are always the emotional and rational aspects to be considered. On the emotional side, you need to consider questions such as:

What levels of risk and debt are you comfortable with?

  • Are you a naturally conservative personality that dislikes the idea of having debt at all? 
  • Do you have a tolerance for risk and a more adventurous spirit? 
  • Will your decision pass the sleep test, i.e. will you lie awake at night worrying about your decision? 

On the rational side, you need to assess the opportunity cost that may be lost if you channel funds into debt repayment. In other words:

  • What investment and growth opportunities might you be able to take advantage of if you direct funds into investment instead of debt repayment? 
  • What results are being achieved in different asset classes and do the potential gains outweigh the benefits of reducing debt?

Should you actually be increasing borrowings to invest more?
There may also be a valid argument in some cases for actually increasing the amount of debt while rates are low. Such debt can be used to invest in property, shares or other more diversified managed investments. Again, this will depend on individual situations, your ability to cope with the risks of such a strategy and your capacity to absorb any interest rate hikes that may occur in the future.

Avoiding the pitfalls of fixed interest investments
The impact of low interest rates on those with fixed interest investments has been quite a burden for some time now, but instead of waiting for rates to turn around, are there alternatives available for those in this situation?

If you are drawing ‘money to live on’ from a fixed interest investment it may be worth considering diversification into share based investments that are delivering dividend income. Certain types of shares or share based managed funds are geared towards this objective and offer the advantage of imputation credits that enhance the value of those dividends. These types of investments offer the secondary benefit of capital growth over the longer term too.

Having said that, there will always be a role for fixed interest investments, due to their stability and security. Those with a low tolerance may not be comfortable to move into equity investments, which will always have a downside risk of capital losses. Of course many of us fall in between the two extremes and a diversified approach that balances capital security and higher income potential will be more suitable.

Developing a strategy that suits you
When considering your options, the vital first step is to know your own investment ‘personality’ and what you are comfortable with. Once that is established, you can then inform yourself more on the possibilities that are available for expanding your investment portfolio and what will fit your personality. Whether interest rates are low or high, these two principles will always apply.

Getting professional advice can help you sort through your situation. A financial planner has the resources and experience to help you make an assessment of your investment personality and can then provide the research and insight to examine investment options that suit your goals. Always seek professional guidance before making changes to your investments.

How do you feel about low interest rates and the effect they have on your investment decisions? Share your thoughts below.