Effect of repo rate cuts on your cash investments
How the interest rate cuts affect those living off investments, especially retirees5th May 2020
We’ve seen three consecutive drops in the repo rate since the start of the year, the most recent being due to the devastating effects of the Coronavirus pandemic. Together these have brought the prime lending rate down from 10% at the start of January to 7.75% now. This is a welcome relief for anyone paying off debt, but the opposite is true for those relying on positive interest earned.
A simple interest calculation
It’s not uncommon for anyone to have a sizable portion of cash in a money market, call account or similar type of investment. This may be kept as an emergency fund, a special savings fund, or perhaps living expenses for a calculated period. Such low-risk investments are ideal for people needing to preserve their capital, and can be especially attractive to retirees, who may not have the luxury of time on their hands to recover from inevitable market lows.
Although less risky, these are, unfortunately, not risk-free. Someone who had invested R200,000 in an interest-bearing account at the beginning of the year could easily have expected a return of at least 8%. That’s R16,000 of interest for the year using a simple calculation, and around R600 more using a daily compounding calculation.
With the 2.25% drop in the interest rate this year, the expected interest for the year drops to R11,500. That’s around 38% less, which could have a significant effect on one’s wellbeing.
People who rely on a monthly income from their cash investments will need to factor in a reduced growth rate, and live off a slightly smaller amount each month. This may be manageable during the lockdown period, as – for most people – daily expenses are generally lower. If, however, your circumstances are such that you need the full amount that you usually withdraw, it means that your money may run out sooner than your calculations predicted.
Other options for your cash
If you have a significant amount of cash, you may consider fixed deposit accounts that offer a slightly higher return, or even the RSA Retail Bond, which is priced off the bond rate and not the repo rate. This is currently paying 9% for a three-year fixed deposit and 11.5% for a five-year period.
A guaranteed annuity is also a great option for people nearing, or in, retirement, as they offer a guaranteed income that is linked to inflation, which translates to financial peace of mind.
Tough times ahead
The current COVID-19 situation is unprecedented, and affects everyone. Although epidemiologists, historians and medical professionals have, for years, been saying that it’s not a matter of if we’ll suffer a pandemic, it’s a case of when, most financial institutions have not taken such a possibility into their planning.
We don’t know what the next few weeks or months have in store for us, as we slowly ease out of the hard lockdown, and we don’t know how long it will take for the local economy to recover, nor what measures the government will put in place. So the best you can do is to assume the worst for now, tighten your belt and cut down on luxuries. Keep in mind that further interest rates cuts are possible.