Investing for retirement just got harder: thankfully dividends are still coping with negative interest rates

Don Hamson

Don Hamson

Investors, and particularly Australia’s 3.8 million retirees, should review their income generating investment strategy in light of the RBA’s third  rate cut decision, according to Australian funds manager Plato Investment Management (Plato).

While beneficial to homeowners and people trying to buy a home, rate cuts also see Australian retirees receive less income from their floating rate income investment assets. Even before today’s decision, interest rates have fallen significantly in Australia.  According to the RBA, 1 year term deposit rates have fallen 70bp already this year, to 1.45% at the end of August.  10 Year Commonwealth Bond yields have fallen even further, dropping from 2.32% at the end of 2018 to around 1% at the end of September.  With the latest Consumer Price index of inflation registering 1.6%, that means that interest rates are now negative in real terms from overnight cash through to 10 year bonds.  After inflation, not to mention taxes, investors are going backwards.

Don Hamson, Managing Director of Plato, said some market economists were predicting that the Reserve Bank of Australia may cut two more times over the next year, although personally he is not in favour of further interest rate cuts.

“Returns on cash, term deposits and products linked to bank bill rates will likely continue to fall under that scenario. Many income-related products, like income securities or bank hybrids are priced at a margin to bank bill rates, and we have already seen 90-day bank bill rates fall more than 1% this year, which is already crimping their income.

“Mortgage holders will benefit from this rate cut, although I don’t expect banks to fully pass on all of the cut.  On the other hand retirees living off cash-linked income are already struggling to make ends meet, and this cut will further crimp their income.  So, it is very timely for retirees to reconsider their income generating asset mix.  Thankfully, given the somewhat surprising election result, retirees can continue to bank on receiving franking credits from Australian share investments.”

Dr Hamson notes that at a time when interest rates are hitting all-time lows in Australia, dividends paid by Australian companies have never been stronger.  Despite a lot of negative commentary around the recent August reporting period, Plato still calculated that the dividends paid by companies that it follows increased on average by 9% compared to the same time last year, with the median increase being 3%.

However, not all investors and retirees have benefited from this dividend bonanza. Many, retirees in particular, need to reassess their income generating investments to ensure they are invested in the best possible income generating equites, not just the big four banks and Telstra, Dr Hamson says

“Dividend increases, for example, have been largely concentrated in the resources sector, with traditional income stocks like the big four banks and Telstra either maintaining or cutting dividends.

“A cut in interest rates – while it won’t lead to an increase in dividend income – may lead to increased investor demand for dividend paying stocks, potentially raising the capital values of some.”

Dr Hamson adds that falling interest rate expectations have been the major driver of higher share prices in 2019.

Dr Hamson also welcomes the Morrison government’s retirement income review.  “Retirement income offerings tended to be a one size fits all approach. With over five million baby boomers moving into retirement, the need has never been greater for new and innovative retirement income solutions for Australia’s retirees.”

Plato is a leader in retirement income generation and highlights how active dividend investing can provide a regular income plus capital gain from the underlying share. Its listed investment company (LIC), PL8, is the only LIC to pay regular monthly dividends.

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