The income dilemma

A dilemma for self-funded retirees that’s been brought about by falling term deposit rates is where will their income come from?

One of the few positives to result from the Global Financial Crisis (GFC) was the high term deposit rates on offer. During 2008, rates averaged about 6.5% and while steadily declining, they still averaged 5.5% through 2011. Today, term deposit rates are as low as 3.7% and falling1.

For many self-funded retirees this could represent a fall in income of over 30%. This can have a real impact on retirees balancing increased living costs such as food and utilities.

While the GFC was known as a capital crisis, the drop in term deposit rates is creating an income crisis. Put simply, retirees have less money in their pockets.

For individuals in this position there are three possible options:

  • Spend less
  • Use capital
  • Find other income sources

Having worked their whole lives to fund their retirement, there are not many retirees that would want to start spending less, nor would they wish to diminish the investments already made, thus ruling out options one and two.

Therefore, with term deposits down, it has become necessary to search for other income sources. The solution is to diversify income sources, which could include:

  • Increase share market exposure – The industrial sector is currently providing 6–8% income return on average and some selected resource stocks are providing higher income returns. By way of comparison many of the banks are providing income returns of 7–9% when including franking credits.
  • Increasing property exposure – Listed property trusts seem to have learnt from the lessons of the GFC. There are more ‘rent and manage’ property trusts rather than development trusts and the yields on these tend to be between 6–8%.
    It is important to exercise caution with the strategies above, they ought to be implemented with due consideration to your appetite for risk. There is no point in achieving a 7% income return if you lose capital.
  • Change banks – Banks have been searching for capital post GFC, a trend that is likely to increase with upcoming changes to global regulations under the guise of the Basel III standards.
  • Other fixed income areas – Other fixed income areas such as “hybrid” raisings from banks and large corporates are becoming more prevalent. An example being the CBA Perls VI and Woolworths Notes. These carry longer terms than term deposits, with some containing equity conversions.
    As you are lending your money to the institution, the terms need to be carefully examined, including the institution’s ability to repay. These quite often pay an extra 3–4% more than term deposits and while carrying extra risk they could be considered.
  • Direct corporate bonds – With the health of Australian corporate balance sheets, direct corporate bonds should be considered. This is lending with defined maturity terms to large corporates and quite often the rates can be 1.5–2.5% more than term deposits. The most important factor here is assessing the ability of the Corporate to repay the debt and interest within the term of the loan.
  • Be aware of guaranteed returns – Lastly, we caution investors in relation to many schemes and operations that provide “guaranteed” returns. A large financial group in Melbourne, “Banksia”, recently failed leaving $660 million in debentures unlikely to be paid to investors.

If you have not reviewed your investment portfolio recently, please contact your local William Buck Wealth Advisor to discuss.

1 Reserve Bank of Australia. Based on Retail Bank term deposits of $10 000 over a 1 year term