Low inflation is here to stay and it will wreck your investment expectations. Get used to it because we are all going to be forced to adjust.
It means reassessing everything. From how long it will take to save for a home deposit to what you’ll need to contribute for retirement.
Remember when we used to assume a 10 per cent annual return on investments… mainly because of high inflation and was easier to do the maths. Now we’ll have to get used to less than half that.
The ripple effect of low inflation on your finances is huge.
When prices are falling, consumers and businesses have less incentive to spend or invest, as they expect things will be cheaper in the future.
As a result, the economy can get locked into an ongoing cycle of low growth and low wage growth. As Tim Harcourt, J.W. Fellow in Economics at the University of New South Wales, explains “when prices are falling you don’t have the same pressure on wages anymore, resulting in pretty stagnant wage growth [in Australia]”.
Here’s what this brave new world of low inflation means for you.
Savings and investments
To combat low inflation and drive growth, the RBA has slashed the official cash rate to a record low of 1.75%, with many experts expecting further cuts will follow.
A low cash rate means the returns offered by savings accounts and term deposits are also at record lows, so you’ll need to look elsewhere if you’re searching for higher returns… and take on more risk.
Shares and managed funds are one way investors can reap higher rewards. According to Ben Nash, Director and Financial Planner at Pivot Wealth, “when interest rates are this low, business can get a real boost on the back of cheap investment loans”.
“The impact is that buying shares or share type investments such as managed funds can provide higher returns when interest rates are low, because as an investor you benefit from part ownership of the company and the higher return they make on their business,” he says.
Low interest rates also mean it’s never been cheaper to borrow money to invest in property; over the last few years this has been one of the key factors pushing up prices in our capital cities.
And while the extreme growth we’ve seen in places like Sydney and Melbourne is tipped to slow, “it does seem likely that in the current low rate environment property prices will remain supported, at least in part, by lower interest rates,” says Nash.
But just because you can borrow, doesn’t mean you should. Prices won’t increase forever and interest rates won’t always be this low, so be careful and make sure your investment stacks up long-term.
If you already have a home loan and the variable interest rate is falling, it’s a good idea to try and keep making higher repayments. After all, it makes sense to pay off as much of the loan as possible while it’s cheap to do so.
As we’ve outlined, the prices of goods and services are broadly falling, which is good news for the family budget.
The flip side of this is wage growth is also slow, meaning forming good financial habits are more important than ever in order to get ahead.
Sit down with your partner and put together a plan to take control of your spending, try to divert any additional money into savings or investments and set up a rainy day fund to cover unexpected expenses.
Financial pressures can put a strain on any relationship, so it’s a good idea to talk about money with your partner once things start to get serious.
Here are five tips to help you manage your money as a couple.
- Be open about money
Build good habits and be open about money early on.
You should be able to trust your partner with knowing your financial situation, and it will help prevent problems down the track.
- Understand each other’s values and goals
It’s important to be honest with each other about your financial values.
Once you’re on the same page it makes managing money so much easier, from the everyday issues to big life decisions.
- Line up spending habits
To avoid arguments over money, make sure your spending habits are compatible.
A budget will help to create a bit of discipline.
- The joint account
A joint account can make the process of managing money together much easier.
Make sure to have a fair system for allocating money to the account, and don’t abuse it for personal purchases.
- Don’t be financially ignorant
Each partner should have a basic understanding of money.
Start by taking an interest in the financial news, and for more complex issues it can be helpful to see a financial planner together.