Noel Whittaker
Noel Whittaker

Expect further interest rate cuts

THE big news is a further drop in interest rates - and there are further drops to come.

The interest rate cycle will not reach bottom until the economy turns around, and from all reports that is a long way off.

It's interesting to reflect where interest rates have been. For example, on December 18, 1990 the then governor of the reserve bank Bernie Fraser announced a drop in rates from 13% to 12%. Today at 3% interest rates they are getting close to historic lows.

At this time you need to think of a concept called relative attractiveness - this means how attractive is one course of action as opposed to another. If interest rates are 15%, it looks pretty attractive to leave your money in the bank on term deposit, but if the best you can get on your money is 3% it looks attractive to buy shares or property that are earning better than 5%.

If you have a home loan, and have taken my advice and are using a variable interest rate, the strategy is simple - keep up your payments at their present rate. This means you will pay more money off the principal.

It's a different matter if you are a self-funded retiree.

All the statistics show that Australians are putting money away in bank deposits at an ever increasing rate,  which is usually a good indication that it's a good time to buy growth assets. As Warren Buffet has said repeatedly the time to buy is when people are fearful, and the time to sell is when people are overly optimistic.

Of course you need to take your attitude to risk into account but you are kidding yourself if you think that money in the bank is risk-free. Imagine you had $100,000 in the bank and it earned $4000 this year in interest. For an average income earner, tax would take $1540, and inflation would take $3000. This means your income of $4000 has to be reduced by $4540 when tax and inflation are taken into account - that's a negative return!