The cash rate reduction and your portfolio
Following the RBA cash rate cut in August to 1.5%, the lowest its ever been, its important for SMSF investors to understand the implications for their investment portfolio.
In August the Reserve Bank of Australia (RBA) followed up its May cut to the cash rate with a further 0.25% reduction, bringing the rate to 1.5%, the lowest it has ever been.
This has implications for investment portfolios, as a change to the cash rate has consequences for all asset classes, making some relatively more attractive and some relatively less attractive.
It’s important for SMSF investors understand this dynamic, and the potential for the recent rate cut to impact long-term investment returns.
Share market returns
Given most self-managed super fund investors’ portfolios are heavily skewed to local shares, the first impact that is important to understand is the deflated cash rate’s effect on the equities market.
One of the main reasons why the RBA cut the cash rate was in response to declining inflation. In some ways sluggish inflation is good for companies, because it means their input costs – for instance fuel and other materials – are maintained, or even falling, which should help them maintain earnings, other factors notwithstanding.
The reduction to the cash rate is also positive for businesses with substantial debt. While most listed companies lock in long-term funding with lenders, including the interest rate they pay, there will be opportunities for businesses whose funding lines are being negotiated now or in the near-term, to press lenders for a lower interest rate.
Nevertheless, there are winners and losers when it comes to the effect of the rate cut on different industry sectors, and parts of the economy.
The rate cut isn’t positive for importers as it devalues the Australian dollar and makes it more expensive to buy products and services overseas. The reverse is true for exporters. Thanks to the reduction in the value of the Australian dollar, our exports, including the commodities we ship overseas such as iron ore and coal, also become cheaper, which makes Australian exports more competitive in global markets.
The cut is also positive for consumer businesses. This is because it will mean lower mortgage repayments for many homeowners, which translates into more money in their pockets to spend on discretionary and non-discretionary items, which means higher profits for many of these businesses.
Overall, the cut should also increase capital expenditure by big companies, which should lead to improved performance down the track. But it is important to keep in mind that the reduction to the cash rate does indicate softening economic conditions, which could impact the performance of listed companies in the near and longer term.
Property market conditions
The rate cut is also generally good news for property assets, both residential and commercial.
Most property assets have associated borrowings, and the rate cut will mean lower interest payments for many investments in this category. This should improve the return for investors.
But it’s also important to be aware that a cut to the cash rate could prompt heightened activity in property markets, given it’s now cheaper to borrow to invest in these assets. The risk is this will push up the price of property assets, as more people come into the market looking for investments.
While the lower cash rate should be broadly positive for shares and property, the same cannot be said for cash and fixed interest assets. The return from these investments is likely to decline, from an already very low base.
This is not to say investors should shun cash and fixed interest altogether. They usually form some component of every balanced portfolio, to help ride through market cycles.
However, the risk for investors with too much exposure to cash or fixed interest is that their returns will be lower than previously predicted when the cash rate was higher.
The right asset class allocation is different for every investor, depending on the time to retirement and risk profile. While most investors’ long-term investment goals won’t change as a result of the lower cash rate, it’s important to consider how interest rate movements will affect the portfolio’s performance and assess the mix of assets to ensure they can still meet members’ needs in retirement.