With interest rates set to remain lower for longer, generating adequate income is an increasing headache for retirees and their advisers.
The great rate collapse was supposed to be temporary. As an aggressive policy response to the global financial crisis (GFC) of 2008, central banks in the US, UK and Japan deployed near-zero interest rates to encourage borrowing and spending and ignite their economies.
During the crisis Australia’s interest rates weren’t pushed down as far as those in other nations, but in the years since 2008 they have been cut to record low levels. And there they have stayed, in Australia and elsewhere, from the UK to Singapore.
Some 21 central banks have cut their rates this year already, and there has been talk of the Reserve Bank of Australia (RBA) dropping rates further. The recent gyrations in China’s share market and a slowing in China’s economic growth have applied yet more pressure to keep rates low.
The US Federal Reserve – the biggest single influence on official short-term interest rates worldwide – has cut deeper than most other countries. US officials have been heading towards a rate rise for months, but no one expects those rates to go very high while US inflation remains so low and employment stays weak. The US continues to suffer from the same unexpectedly slow growth that has afflicted economies around the world.
Meanwhile, the great rate collapse has had another effect. Encouraging borrowing and spending through low interest rates means being tough on savers, who have been lumbered with several years of tiny returns on their cash investments. That has repercussions for millions of people hoping for a comfortable retirement. Worse, no one can really predict when those returns will rise again.
Why economic growth is still stuck in the slow lane
RBA governor Glenn Stevens acknowledged this in a speech in April in which he asked how a low-rate world would generate enough income for retirees. Implicit in that concern was a belief that interest rates could stay unusually low for some time yet. Stevens, who speaks frequently with fellow central bankers around the world, seemed to be at least contemplating a global future in which low rates were a semi-permanent condition.
Re-running the retirement numbers
The possibility of continuing low rates is forcing some recalculations from those who had once expected the great rate collapse to be a brief passing phase.
One such recalculation was released in May by superannuation industry leader Jeremy Cooper, the former head of an Australian Government investigation into retirement incomes and now the chairman of retirement income at Challenger.
Based on Challenger’s numbers, even A$1 million would at current interest rates deliver only about A$1297 a fortnight – that’s almost the same amount as the current Australian aged pension for a couple. For Australians who thought their sizeable nest eggs would afford them a comfortable retirement, these projections may have been a nasty shock. A similar problem raises its head anywhere that retirees depend on investment returns.
Are low rates the new normal?
Challenger’s projections were immediately challenged, based as they were on assumptions of continued low rates. Interest rates would “of course, eventually return to normal” declared one newspaper investment writer, adding that most investors were putting money in shares and property as well as cash and bonds.
Many economists also expect rates to rebound sometime soon. Saul Eslake, one of Australia’s most respected independent economists, expects the “new normal” for returns to be just a little lower than those enjoyed by investors in years past. He believes the RBA will start lifting the cash rate early in 2016, and push it up to between 3.75 per cent and 4.5 per cent over the next three years, leaving it about one percentage point below its 20-year average.
If economists such as Eslake are right, retirees still face lower incomes from cash and bonds than they might have been expecting. Eslake predicts retirees will be increasingly attracted to equity in listed banks and other higher-yielding stocks.
“Assuming they’re buying these stocks for yield, and have no intention of selling, they’re unlikely to be too worried about share price volatility,” he says.
Investors will have to adjust their expectations in a changed investment landscape. While yields on a broad spectrum of asset classes will improve over the next decade, returns are still likely to remain lower than what was average in the 20 years before the GFC.
“Lower than average returns are no reason for panic, nor should [they] be entirely ignored by investors and advisers,” says Eslake.
“They will impact the rate at which the living standards of retirees, those still working, and their children improve over time.”
Clients look for risk
Economist Jim Minifie of the Grattan Institute has been thinking through the impact of continued low rates. He says global investors are still clinging to the safety of cash and bonds, despite the dismally low premiums. That’s not surprising, he says, with corporate profitability still shaky in the wake of the GFC. However, he expects even the most risk-averse self-funded retirees to search for higher – and riskier – returns, to avoid drawing down capital too fast. In the medium term, that should keep money flowing to equities and property.
Having watched “boomer seniors” literally run out of money by drawing on annuities based on pre-GFC modelling estimates, Maple Tree Wealth managing director Ron Malhotra says the financial advice community is hell-bent on ensuring future retirees don’t do likewise.
“We’re saying to clients [that] interest rates will go up, but won’t return to where they’ve been over the last 30 years,” he explains.
"Lower than average returns are no reason for panic, nor should [they] be entirely ignored by investors and advisers." Saul Eslake
While Malhotra sees at least a desire among clients to learn about riskier assets, he also worries that they still aren’t giving enough consideration to asset management.
The longer that low interest rates continue to squeeze living standards for Australia’s self-funded retirees, the more Malhotra expects them to look for more creative solutions. These may include retirees downsizing their homes to free up capital, reverse mortgages, working longer, spending less, greater dependence on the age pension and, as a last resort, moving to lower-cost economies in parts of Asia.
Tim Rocks, head of market research and strategy at BT Financial Group, believes retirees must become more active in portfolio/money management, and look for alternative asset classes. “The value of good advice on the best risk-adjusted returns just went up,” he says.
Glenn Stevens on the challenge of low rates
Reserve Bank of Australia governor Glenn Stevens, in an April 2015 speech, asked how savers would get by in a world where low interest rates have become the norm:
“How will an adequate flow of income be generated for the retired community in the future, in a world in which long-term nominal returns on low-risk assets are so low?
“This is a global question. Just about everywhere in the world the price of buying a given annual flow of future income has gone up a lot. Those seeking to make that purchase now – that is, those on the brink of leaving the workforce – are in a much worse position than those who made it a decade ago. They have to accept a lot more risk to generate the expected flow of future income they want.
“The problem must be acute in Europe, where sovereign yields in some countries are negative for significant durations. But it is also potentially a non-trivial issue in our own country.”