The last few months of 2011 saw online savings account interest rates fall substantially and even lower rates could be on the way so where should you put your savings to ensure a reasonable return in 2012?
In August 2011 Virgin, Rabo Direct and UBank were all offering 6.51% introductory interest rates on their online savings accounts. Citibank’s online introductory rate was a competitive 6.4% and several others were hovering around the 6% mark.
By December, the online savings rates on offer had declined significantly, UBank’s 6.11% (if you deposit a minimum of $200 per month) was the best available and most other competitive deals had fallen below 6%.: 5.85% was looking like a good deal.
Rumblings from the Reserve Bank about further official interest rate cuts in the New Year don’t bode well for savings rates either. Some economists are predicting two more official rate cuts by May, which could see the Reserve’s cash rate at 3.75% by mid-year.
Some lenders have been making a stand about their right to adjust rates as they see fit rather than in line with the RBA’s settings. In plain language that means you may not end up paying less interest on your home loan just because the RBA believes rates should be lower.
Rates paid on deposits, however, are a different story. You can expect banks and mutuals not to think twice about dropping the rates they’ll pay on your savings if the official interest rate goes lower.
“If there are further cuts, then cash returns aren’t going to be as great as what they have been”, says Michael Karagianis, investment strategist at MLC.
The official inflation rate is also currently sitting at 3.5% and the double-whammy of inflation and lower savings rates presents a big challenge for many investors and savers right now.
Cash in the form of bank deposits have been seen as a ‘safe haven’ from the volatility of investments like shares and managed funds in recent years. Cash also gives investors a safe place to park their money while they observe where property prices are headed.
Deposits of up to $250,000 held with an authorised deposit-taking institution (ADI – banks, building societies, credit unions and mutual banks) are also government guaranteed.
However, if savings rates fall, you will have to start weighing up the ‘opportunity cost’ of keeping your money in the bank. Consider what your real rate of return is after inflation and taxes.
Remember that interest earned on bank deposits (online savings accounts, cash accounts and term deposits) is taxed at your marginal rate, which can be as high as 45 cents for each dollar if you taxable income is over $180,000.
Suddenly the real rate of return on a 5.85% online savings account is not even keeping pace with inflation. In other words the real value of your savings could be falling.
So what should you do with your savings in 2012?
1. Consider locking in a longer-term rate
One- and two-year term deposits are still offering 5.5% and 5.6%. Shorter-terms (180 days) are still paying up to 6% but if the RBA does cut rates in February and April or May, you may have to settle for a much lower rate when you rollover your cash. Always ask for a better rate than currently advertised and do some shopping around just prior to when you want to invest so you can scoop up blackboard specials and other term deposit offers.
2. Hedge your bets
Consider taking some money out of cash to take advantage of great buying opportunities in property and shares. If you’re a long-term investor (at least five years) both the domestic share market and residential property markets currently offer some great, cheap buying opportunities.
By diversifying out of cash you’re still taking advantage of the certainty of government-guaranteed savings vehicles but you’re also looking at ways to lock in healthier long-term gains.
“Now the danger is that people may have too much cash exposure, and the reality for most investors is that you need a well-diversified portfolio. That will potentially give you a much better outcome”, says Mr Karagianis.
Cash-flow-positive properties and stocks paying healthy dividends can also boost your sources of regular income as well as chances of long-term capital growth.
3. Take a bit more risk
Fixed-interest investments such as corporate bonds and debentures are riskier than bank deposits, and they’re certainly not guaranteed but they do pay higher interest rates than term deposits or online savings accounts.
If you plan to buy debentures just check that the debenture issuer meets the ASIC benchmarks before you invest.
4. Sit tight
If volatility and uncertainty continue to be the primary characteristics of equity markets, gold and foreign exchange markets, perhaps accepting a lower rate for government-guaranteed savings is something you just have to accept for a short period of time.
Keep an eye on those other markets and look for buying opportunities. Cash gives you the opportunity to act swiftly when you see a great bargain.