Retirement Cashflow & How to Maintain In a Low Interest Environment
Low interest environments are great for borrowers, but can be a disaster for investors, particularly for those who rely on the interest on investments for their cash flow.
Even with interest rates as low as they are, a drop in rate from 3% to 2% reduces your income by an eye watering 30%, and a drop from 2% to 1% can leave you with an income shortfall of a further 50%. This can have a huge impact on your cash flow situation. And despite what the Big 4 are saying, it looks unlikely the RBA will be raising the cash rate any time soon.
So how do you protect your financial position against long-term low interest rates as a self-funded, or even partially self-funded retiree?
The Difference between Cash Flow and Income
It may seem cashflow and income are one and the same, but there is an important distinction you need to understand when you retire.
Cash Flow – is the amount of money that goes in and comes out of your household in a week or month for you to use on living expenses. This might include investment income, a government pension, the maturity of investments or sale of assets.
Income – is the amount of money generated by your investments and, if you have sufficient funds, is not always taken into cash flow. It may be re-invested to form part of your ongoing investment capital.
In retirement, you need to think carefully about your cash flow, to ensure you have sufficient money coming in each week or month to meet your non-discretionary and discretionary needs as well as occasional lump sum needs, like the purchase of a new car, whilst at the same time retaining as much of your capital as possible to continue generating income.
How Low Interest Rates Affect Self-Funded Retirees
Some months ago, we wrote an article on Retirement Income Strategies, where we talked about the Sequence of Returns. Put simply, what this means is that if you retire in a low-interest period you may be forced to use capital to supplement your cash flow. This erodes your capital balance so that, even when rates return to reasonable levels, you may not earn sufficient interest to meet your financial needs.
Putting in place strategies to minimise this effect can help protect your long-term financial security.
Negative Interest Rates
Worse for retirees than low interest rates is the spectre of negative rates, which are sometimes used by central banks in a deflationary environment to encourage lending and spending. This increases demand, and generally rates return to positive pretty quickly.
Negative interest rates are great for borrowers as they encourage lending for productive purposes. However, for depositors it means you pay the bank to hold your money, which is problematic for retirees.
Potentially, this can cause people to withdraw funds from financial institutions, and apart from the obvious risk of keeping your money in a coffee tin under the bed, mass withdrawals can weaken the banking system and cause widespread financial instability.
Fortunately, while APRA has suggested we should be ready for negative interest rates, the RBA still believe it is highly unlikely they will use this unconventional monetary strategy.[i]
Negative Even When It’s Not
Rates don’t need to actually be negative in order to impact the financial position of savers. If the interest rate you are earning is lower than inflation, the money you have invested is effectively being reduced by the difference between the rate you are receiving on your deposit and the rate of inflation.
This means finding alternatives to the Big 4 and traditional products like Term Deposits is critical in a low interest environment.
Retirement Income Alternatives
So, when interest rates are low what are the alternatives for a retiree needing to manage cash flow for their retirement?
A retirement annuity provides you with a regular cash flow income and can be set up for either a fixed term or lifetime income. Whilst these are low risk, and provide certainty around your monthly cash flow, they are tied to the interest rate at the time of purchase. So, if rates are rising it’s worthwhile holding off, but if you are in an environment where the interest rate is dropping, these provide a great way to insure against relative loss of income.
These provide an alternative to direct investment in the share or property market. There are any number of Managed Funds with different investment strategies so you can choose one that suits your risk profile, your interests, or even your ethical leanings. However, despite the range of options, there is always a risk associated with investing in shares. That said, when the returns are good, they will outperform interest rates offered by banks.
Including high dividend yielding shares, or income-based shares, in your portfolio will help provide continued cash flow. Of course, there is volatility in the stock market which means dividends will not always be reliable. And it is always possible that companies will suspend dividends in difficult periods.
It is also important to include growth shares in your portfolio to help protect against the effects of the Sequence of Returns we mentioned earlier.
Convertible Preferred Shares & Capital Notes
Here we are starting to get into more complicated territory, so if you are thinking of Convertible Preferred Shares or Capital Notes its essential to talk to a financial advisor.
Convertible Preferred Shares – are essentially fixed income securities, which you can choose to convert to common stock after an agreed period of time. These stocks allow you to participate in investing in growth companies but will insulate you against the shares not meeting expectations.
Capital Notes – are unsecured debts a company may take on to cover a short-term need or liability. As the investor, you loan money to the company involved for a fixed term at an agreed rate of interest. Over the term you receive interest payments, and at the agreed date your capital investment is returned.
For more suggestions on protecting your retirement income and cash flow in a low-interest environment, check out our article on Ideas for Surviving Low Interest Rates.
The Right Advice
Getting your Retirement Income and Cash Flow Strategy right can be tricky, particularly in a low interest-rate environment, so it is important to seek the help of a qualified and experienced financial advisor. And as we always say, diversity is key. The more baskets you have your eggs in, the better protected you are against loss.
If you are concerned about maintaining your retirement cash flow without eating into your capital, Manly Financial Services can provide you with the advice and expertise to help you weather the cash flow drought. Please give us a call on (02) 9876 3388 or contact us via the below link.