Asset-Rich and Cash-Poor: The Low-Rates Dilemma

I recently met a new client,  a divorcee with two teenage sons who, on the face of things, appeared to have no financial worries. She has $6.5m in total assets, including a family home with no mortgage, and requires, she says, $120,000 a year to live on. Surely not a problem. However, when we dug into her asset base, things were a lot different to what they appeared.
Her principal residence in inner Melbourne is unencumbered and valued at $1.5m.

Her investment portfolio totals $5m, of which $3.5m is tied up in residential investment properties which, although they have appreciated in value, deliver little income. The remaining $1.5m is spread across equities and fixed interest, which average a yield of about 4 per cent per annum, producing $56,000.

Total income from her investments of $70,000 represents little more than a half of what she requires. If she drew on the invested capital to supplement her income it would disappear within 10 years, which for a 57-year-old would be disastrous. For those in a similar situation considering their future financial security, understanding how aged care costs can impact long-term financial planning is crucial. You can learn more in our Complete Guide to Aged Care Costs in Australia, which provides in-depth insights on managing such financial challenges.

As a married person she was not dependent on income as her spouse’s salary more than covered their living expenses. In her changed circumstances her invested assets now have to support her new lifestyle and, while a $5m investment portfolio seems sufficient, the mix of investments including a heavy exposure to residential property means her income requirements are not being met.

My client is in many ways a victim of the dramatic reduction in interest rates in recent years, and represents a good case study of how people must adapt to meet changing circumstances. Where once $1.5m on term deposit would generate a reasonable income (say, $75,000 a year at 5 per cent), today that same amount generates far less ($18,750 a year at 1.25 per cent). She initially said she was loathe to sell some of her properties, but it was something we  recommended she consider. Otherwise, the numbers didn’t add up.

Selling half of her property investments ($1.5m) and investing the proceeds at 4 per cent would produce income of $70,000 a year. Dramatically lower interest rates is only one of several key issues affecting older Australians. More and more people wish to retire earlier and most are living longer. People who don’t prepare for these things could end up in genteel poverty.

Two generations ago people retired at 60 and many died at 70, so their savings needed to support them for only 10 years. Today many people are living into their 90s, so their savings must last three or four times as long. Meanwhile younger Australians are watching this in horror; it is they who will have to fund social security for the burgeoning number of retirees.

So, what should investors do in a low interest rate environment?

• Reduce passive assets. Passive assets like investment properties have been a bonanza for many people, but land tax on investment properties (which increases exponentially as the value of a property’s land is revalued), increasingly lower returns, higher outgoings and more demanding
  tenants mean they can be a drain on finances.
• Reassess spending. Until interest rates recover, investors need to reassess what they really need and temper spending accordingly.
• Delay retirement. Investors must take stock of their investments and savings and do the maths on possible length-of-life
  scenarios. Will your savings last you and your spouse 40 years?
  Can your lifestyle be maintained at current income levels? What happens if there is a downturn in the stockmarket? Do you have the resources to enter aged care later in life?
• Beware of being too generous to children or grandchildren. Several generations of Australians have assisted their children financially, principally by helping them enter the property market and by paying school fees. Today, this needs to be reassessed.
• Reassess your portfolio, but always align it with your risk profile. Blue chip companies paying dividends that yield greater than 4 per cent, ideally fully franked, would normally make up the bulk of a conservative share portfolio.

Be wary of changing your risk profile in the search for greater returns; there must always be a balance in risk and reward.

Note: Figures are accurate as of the publication date