Related articles
In recent years, cash has stood out among defensive assets, reclaiming its title as ‘King’ thanks to steep interest rate hikes by the Reserve Bank of Australia (RBA). Since the cash rate peaked at 4.35% in November 2023, savers have been able to access term deposit and high interest savings rates of 5% or more.
However, financial markets move in cycles, and cash’s high point has passed as inflation cools and economic activity slows. Leading 12-month deposit rates have already dropped by 20 to 65 basis points over the past six months, despite no change in the official cash rate1.
The King is losing its crown as markets anticipate Australia will follow major central banks in cutting rates to stimulate the economy2.
This shift poses a challenge for savers – particularly conservative retirees – who rely on interest income to sustain their lifestyles. As cash loses its lustre, we explore alternatives for investors seeking to maintain income while preserving capital.
The stinging impact of falling rates
You might be exploring income options out of curiosity, concerned about declining rates as your term deposit renewal approaches, or facing the end of a honeymoon period on your latest savings account.
Regardless of your situation, it’s crucial to understand how changes in interest rates can affect your purchasing power – particularly in retirement.
An illustrative example: Alina and Ken
Consider Alina and Ken, a risk-averse retired couple with $1.5 million invested in a term deposit earning 5% interest. This generates $75,000 annually, the exact amount they need to live comfortably3 and cover expenses for travel, dining, and leisure without touching their principal.
Their goal is to preserve their savings to pass on to their children to buy their first homes and make charitable donations.
However, things change when their 12-month term deposit matures. Upon renewal, they discover the best available rate is now 4.5%. A year later, the rate falls to 4%, cutting their income further. Meanwhile, the costs of their hobbies, meals, and insurance continue to rise due to inflation.
Here’s a breakdown of how these rate changes impact Alina and Ken’s finances:
| Term deposit rate | Amount invested | Annual income | Projected annual expenses^ | Gap between income and expenses | Reduction in purchasing power (bank payments plus inflation) |
| 5% | $1.5 million | $75,000 | $75,000 | $0 | 0% |
| 4.5% | $1.5 million | $67,500 | $77,250 | $9,750 | 12.62% |
| 4% | $1.5 million | $60,000 | $79,567.50 | $19,567.50 | 24.59% |
Source: Betashares. Assumes term deposits are renewed annually. ^Assumes a 3% inflation rate, based on the RBA’s target range of 2-3%. Calculations do not take into account taxes or fees.
By their third renewal, Alina and Ken have experienced a whopping 25% loss in purchasing power, driven by the combined impact of falling interest rates and rising living costs.
What are Alina and Ken’s options?
Under this scenario – and assuming they have no other income sources – Alina and Ken face the following choices:
- Dip into their principal to maintain their current lifestyle, depleting the nest egg they hope to pass on.
- Cut back on lifestyle expenses to match their reduced income and live “less comfortably” during their golden years.
- Consider part-time work if they wish to preserve their savings while maintaining their quality of life in retirement.
- Invest a portion of their capital in equities, introducing risk and volatility they may prefer to avoid.
Alternatively, Alina and Ken could consider other investment options that may allow them to generate attractive returns while offering a high degree of capital stability that is important to them. We’ll explore what these are in a moment.
Ideas for savers seeking attractive income
Our house view is that the RBA will likely start cutting rates in early 2025, joining the Federal Reserve, Bank of Canada, and Bank of England. This expected easing reflects weakening global economic conditions. While this is good news for mortgage holders, it’s a bit of a headache for savers.
We also expect banks to lower term deposit rates more than the cash rate in order to preserve and increase profit margins on the money they lend.
It’s understandable that many income-focused investors might hesitate to move into riskier assets like equities to offset declining term deposit returns. Instead, let’s explore more conservative options outside traditional bonds.
You might be surprised to find that the ASX ETF market has more than 50 cash and fixed income options for those seeking yield and stability. The market cap of these products has jumped 30% to nearly $30 billion in the past 12 months, and according to the ASX, they now make up approximately 15% of the domestic funds under management.
And for good reasons: Cash and money market ETFs allow investors to generate comparable returns to term deposits, all while helping investors maintain low capital volatility. For investors looking to maintain a reasonable level of income while taking on some additional risk, fixed income ETFs may provide options.
While not a bank account, cash, money market and fixed income ETFs allow investors to generate attractive returns with far greater access to ready liquidity. In the face of falling interest rates savers don’t need to stick with term deposits for their cash holdings. There may be other options that are better placed to generate income in the face of rate cuts. Here’s a breakdown of four of options and their current yields:
1. Cash ETFs
Cash ETFs invest in deposits from Australian banks, offering attractive income that generally varies with the RBA cash rate. While not a bank account, cash ETFs allow investors to generate comparable returns to term deposits, but with far greater access to ready liquidity. Based on current data, a saver would need to lock up their cash in a term deposit, on average, for between 8 and 12-months with the major banks to get a comparable interest rate to one cash ETF.
Example: AAA Australian High Interest Cash ETF currently offers a rate of 4.45%*. AAA owns nothing other than cash deposits with major banks, providing high levels of capital stability.
2. Money market ETFs
Investors seeking an enhanced yield from their core cash allocation may consider cash and money market ETFs like the MMKT Australian Cash Plus Fund (managed fund) . MMKT provides monthly income to investors by offering diversified exposure to not only Australian bank deposits, but also a range of more sophisticated money market securities usually only available to institutional investors.
Example: MMKT currently offers an estimated yield-to-maturity of 4.89%* with monthly distributions, providing regular income with a high degree of capital stability.
3. Senior floating rate bonds ETFs
Senior floating rate bonds are a debt security issued by banks that pay a regular coupon (interest) that varies over time. These securities offer income at a variable interest rate and have historically had a high degree of capital stability.
Example: QPON Australian Bank Senior Floating Rate Bond ETF tracks the performance of a portfolio of some of the largest and most liquid senior floating rate bonds issued by Australian banks and currently offers an all-in yield of 5.14%*. This ETF may be suitable for investors seeking regular income and capital preservation.
4. Subordinated debt ETFs
Subordinated bonds are a class of debt security whose rights with respect to payment of income and repayment of principal rank behind (are subordinated to) other classes of debt. Subordinated debt ranks below senior bank floating rate notes but typically offers higher income potential.
Example: BSUB Australian Major Bank Subordinated Debt ETF allows investors to obtain exposure to floating rate subordinated bonds issued by the “big 4” banks. BSUB currently offers an all-in yield of 5.68%*.
*Yields do not take into account fund fees and costs. Yields will vary and may be lower at time of investment. Past performance is not indicative of future performance.
Tips for playing good defense
Rather than sticking to term deposits, investors could consider options including, money marked and fixed income ETFs. This strategy may help investors strike a balance between generating income and managing risk.
1. Diversify across categories
Just as growth investors diversify their portfolios, conservative investors should also spread their investments across various categories.
- Cash and money market securities providing attractive income on cash deposits and money market securities with high levels of capital stability.
- Fixed income securities for investors seeking higher returns and who are for comfortable taking on some additional risk, and may comprise exposure to senior floating rate bonds, subordinated debt, other high-quality fixed income securities and income focused stocks, if risk appetite permits.
2. Match investments to goals
Align your investments with your specific goals and risk tolerance. Cash and money market ETFs provide high levels of capital stability and easy access to cash. On the other hand, senior floating rate bonds and subordinated debt ETFs can offer higher yields for those willing to accept more risk. Always read the PDS and TMD for any ETF you’re considering, and it’s a good idea to consider seeking advice from a financial planner who can assist you in making well-informed decisions.
3. Conduct regular reviews
Stay informed about the economic climate, and review and adjust your portfolio accordingly. In a rising interest rate environment, floating rate bonds (including floating rate subordinated bonds) and cash become more attractive as their yields vary with changes in the cash rate.
Please note any information provided is not a recommendation or offer to make any investment or to adopt any particular investment strategy. You should consider seeking financial advice before making an investment decision.
Conclusion
With the RBA poised to cut rates and term deposit yields slipping, conservative investors will need to tap into a broader toolkit to maintain steady income.
By considering strategies that help strike a balance between generating income and managing risk, diversifying into ETF categories like cash, money market funds, senior floating rate bonds, and subordinated debt can help you manage your cash flow, even as term deposit rates look set to continue their decline.
There are risks associated with an investment in the Funds mentioned in this article, which may include interest rate risk, credit risk, bank sector risk, market risk and, for BSUB, subordinated bond risk and subordinated ranking risk. Investment value can go up and down. An investment in AAA does not receive the benefit of any government guarantee. An investment in the Funds should only be considered as part of a broader portfolio, taking into account your particular circumstances, including your tolerance for risk. For more information on risks and other features of each Fund, please see the relevant Product Disclosure Statement and Target Market Determination, both available on the Betashares website (www.betashares.com.au).
References:
1. The Guardian
2. Australian Financial Review
Annabelle Dickson was previously a journalist at Financial Standard and prior to that at The Inside Investor and The Inside Adviser. She holds a Bachelor of Arts in Communication (Journalism) from The University of Technology Sydney.
Read more from Annabelle.
3 comments on this
there are a lot of assumptions in your calculations above.
Especially as our composting USA friends are about to cut rates.
These rate cuts are engineered to offset the shithole the USA has fallen into.
Wit $34 trillion in note printing any further bail outs are going to bankrupt this country.
An impending recession is well noted and the USA will suffer as will Australia who will fall further behind with increasing pain in our never ending increase in cost of living.
Any retirement investment will be eroded by falling performances over the next 2 years.
Betashares Gold ETF is a great safe haven and should be promoted.
I am surprised that Betashares is in no way advising or promoting GOLD as a safe investment, the returns for me have been staggering
Buckle in as the next 2 years will be rough with most ETF’s retreating from their once bountiful returns.
Luckily, I bailed out in March and invested all in PMGOLD – staggering returns
good luck to all – dont say I didnt warn you
Mr. Fontana, with all due respect, gold does not produce income though I commend you for making a wise investment choice.
With the Fed cutting rates by 0.50%, the reality of significant reductions in interest income is imminent in Australia, so I appreciate the insights this article provided on potential alternatives.
Inflation is in no way under control in Australia. The reason the US and some other countries can now start reducing rates is because they did the hard work of lifting rates well above the RBA cash rate and were able to get their inflation levels under control. The RBA has chosen not to do this and the country in paying the price (literally!) with much higher entrenched inflation. Let’s not forget that the astrologers who masquerade as economists were telling us last year that we would definitely have rate cuts by mid 2024 – it was absolute nonsense and so is talk of rate cuts in “early” 2025.