‘Investors are betting Aussie rates will sink further in 2021. I agree with them’

As we think about 2020, our thoughts go naturally to interest rates. The Reserve Bank of Australia has continued to reduce them – the cash rate now stands at .10 per cent. I fail to understand the point of all this rate-dropping – after all, if you saw an investment opportunity that ticked all the boxes, I’ll bet that a 1 per cent difference in the borrowing rate would make no difference to your decision.

The problem is that this continual rate dropping is doing is making inexperienced investors hungry for yield. Just this week I heard about a small, low-quality suburban shopping centre that sold for a yield of less than 4 per cent. That has to be a recipe for disaster.

And of course, every day I receive emails from people telling me they have all their money in the bank earning minuscule interest and asking what to do. As always, the answer is to take a long-term view, keep at least four years’ worth of planned expenditure in a predictable area and diversify the rest of your portfolio across Australian and international shares.

The big question is, though, where will rates go next year? Unfortunately I believe they will keep on going downward. (I talk about this topic and much more in my new book, Retirement Made Simple, which you can purchase from the Starts at 60 Marketplace here.)

Negative interest rates and bonds

This leads us to bond markets. You may have read this week that the Australian government has offered $1.5 billion worth of March 2016 Treasury notes. The demand was so strong that the offer was 5.47 times oversubscribed. One investor, thought to be offshore, purchased at least $1 million worth of three-month Treasury notes at a negative rate of -0.01 per cent.

This of course begs the question as to why anybody would ‘invest’ in a security paying a negative interest rate. To understand the reasoning, let’s have a quick course on bonds.

Most government bonds pay a fixed rate of interest, with the capital sum repayable on maturity. Now, if I have a bond with a fixed rate of 3 per cent, and interest rates fall generally so that the going rate becomes 2 per cent, then my bond will rise in value.

This is why bond markets around the world have been booming over the past few years as interest rates have tumbled. Therefore, if I buy a bond with a negative rate of -0.01 per cent, I will make a capital gain if interest rates fall further. Obviously, any purchaser of a fixed negative rate security is expecting interest rates to fall further.

The other reason is a currency hedge. For example, if I thought the euro was undervalued, I could buy euro bonds with a zero or even negative rate with the expectation that they would rise in value in Australian dollars if the euro appreciated against the Aussie dollar.

In Denmark now, negative rates are the norm. This means if you buy a property in Denmark, borrowers make monthly repayments but the amount the outstanding loan is reduced by each month is larger than those repayments – that’s attractive to homebuyers, which is why there is property boom in Denmark.

But it’s no good for savers. If your mother placed $100,000 in the bank at a negative rate of 1 per cent, she would receive only $99,000 when that deposit matured in 12 months. It’s a crazy world!

Noel’s new book ‘Retirement Made Simple’ is available on the Starts at 60 Marketplace for $29.99. Click here to buy now before it sells out!

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.