March 23, 2020
Hello quizzical reader
As you know, my articles are designed to take sophisticated topics in the finance and investment world and translate them into a language that us mere mortals can understand (and hopefully make them a little less boring and more fun to read 😉 ).
I want to take a break from all of the COVID-19 news and get to some of the pressing issues that will be facing us well after the virus issue has passed.
What are negative interest rates?
It is important to understand how the entire process works, so let us start at the beginning.
The official cash rate is effectively the rate of funds at which banks can borrow money from the government. This is why there is such an outcry from the media when the Reserve Bank of Australia (RBA) cuts the cash rate and banks do not pass on the discount: the banks are now effectively making a larger profit from you, the consumer, because their costs have been lowered!
Now, a negative cash rate means that the banks need to pay the government for the funds they want to borrow.
This is a clever move by the government on a couple of levels. Firstly, it stops the banks from hoarding gold like the dragon on the mountain and prompts them into spending their funds in reserve.
I will give you an example:
If the cash rate is a -0.5% then the banks are losing part of their capital every year by holding onto the money. If they lend out that same money, they would at least be making a small amount of profit (e.g. by lending that money out at 1%, they would still be up 0.5%).
This is a great way to stimulate the economy. It means that banks want to push money out into the market quickly, which in turn will promote spending, hopefully in the housing market where a great deal of jobs are created.
Do not be fooled. This is not all wins and roses for us at home, there are also some risks for us.
This has a direct impact on your money held in the banks. If you have term deposits or cash savings in the banks then you could receive no interest or even be liable to pay interest on those funds in account!
This is also how the government stops the public from hoarding cash. They want you to spend, buy things, invest in things and get your money into the local economy.
There will be some great opportunities to purchase properties. I will not be surprised to see some fixed- rate loans as low as 2% per annum. (If you do make a move into the property market, make sure you do it in a sensible manner. Get advice from professionals and make the right purchases in the right structures. I will talk more about this in a future article.)
Definitely look into direct assets that are tangible. Keep it local to your country, not only to de-risk but also to contribute to your economy.
The takeaway from this.
Negative interest rates are inevitable. You need to make some smart decisions now before you are forced to make them later. (A good example is if you, were one of the people laughing at the people who were buying up all the toilet rolls… Are you now one of the people who wish you got there first?…)
In the words of good old Benji Franklin “If you fail to plan, you are planning to fail.”
Stay in touch with all of my articles at www.raic.com.au/blog
Take care, keep reading and, send me toilet paper! 😉