Falling Bond rates change everything
Australian bond rates have collapsed over the course of 2019, with the 10-year Government bond rate trading just below 1.0% – and that fall has had a dramatic impact at many points in the investment decision-making process.
Lower bond rates mean that fair value Price-Earnings ratios for equities should increase, commercial property prices should have another leg up. Despite all of this, the chance of investors meeting their objectives will fall – particularly more conservative investors. This is because future returns on all secure assets will be much lower. Term Deposit rates will fall even further over coming months and future returns on bond funds, which have been great over the past year, will be much lower going ahead. The world has changed.
The impact of much lower interest rates on a range of critical investment issues:
- Interest rates lower for longer – but possibly not this low;
- Long duration bond funds will produce low returns going forward, with some potentially nasty surprises along the way;
- Term Deposit (TD) rates are set to fall even further in the coming months;
- Fair value PE ratios for shares have increased, causing forecast longer-term returns for equities to rise;
- Commercial property valuations are likely to rise;
- The probability that investors in Conservative portfolios will meet their financial goals has fallen in most cases. They may face some difficult choices going forward..
Government, Corporate & Mortgage-backed bonds
Government bonds, often referred to a Treasuries or Treasury bonds, are relatively straightforward. The government borrows money from the public in the form of bills, notes, and bonds. For years, these bonds were considered to be “risk-free,” though some might dispute that for some Governments issuers these days. In Australia, it is reasonable to consider them risk free which is supported by the AAA rating they carry. (For Term Deposits guaranteed by the Australian Federal Government, they can also be considered risk free). The interest rates on Government bonds are pretty much the benchmark for every other interest rate in the world, including mortgages. They also give you a pretty good indication as to which way the economy is going, if you know how to make sense of the numbers.
Corporate bonds are debt issued by corporations. Corporates are considered to be riskier than the government, so their interest rates should be higher (because you should be rewarded for taking on more risk), and they generally are. The difference between treasury and corporate interest rates is called a spread.
Corporate bonds are rated by rating agencies, and the higher-rated ones are called investment grade, and the lower-rated ones are called high yield. High yield bonds have higher yields, as advertised, but are riskier and more likely to default. Investment-grade bonds don’t default very often, but people have become concerned recently about the perceived riskiness of lower-quality investment grade corporate bonds.
Mortgage-backed securities are pools of mortgages on residential real estate. Many mortgages are “securitized” into a pool which can be bought by investors. The principal and interest payments are passed through the bond to the investor.
Sovereign/International bonds are bonds issued by foreign countries or foreign corporations. Some of them are denominated in the currency of the issuer, other in US dollars, and some in other currencies. The ones that are denominated in local currency obviously give you exposure to that currency. The currency exposure is generally the overriding concern with these bonds. Sovereign bonds are generally treated as corporate bonds—they trade at a spread to US Treasuries.
What strategies can be used to obtain and retain the Commonwealth Seniors Health Card (CSHC)?
Self-funded retirees of age pension age may be eligible for the CSHC. The CSHC offers several benefits for seniors. This article explains how eligibility for the card is determined and provides some useful strategies to obtain or retain the card.
The CSHC entitles holders to:
- Prescription medicines at concessional rates through the Pharmaceutical Benefits Scheme (PBS)
- The Medicare Safety Net threshold available to Commonwealth concession cardholders
- Bulk billed GP appointments (at providers discretion).
- The CSHC can also entitle holders to other concessions from state and local government authorities, including:
- Free ambulance transport in case of an emergency in New South Wales
- $200 energy rebate in New South Wales
- A once-only stamp duty concession when buying a home valued at less than $750,000 in Victoria
- A ‘cost of living concession’ which is a South Australian government payment towards living expenses.
Existing CSHC holders who have held the CHSC continuously since 19 September 2016 are eligible for the energy supplement. This is a quarterly payment of $92.66 for singles and $69.66 for each member of a couple.
Other holders of the CSHC who are entitled to the energy supplement include:
- CSHC holders who were receiving an income support payment, including the energy supplement, on 19 September 2016 and who then subsequently become a continuous holder of the CSHC will also continue to be paid the energy supplement. Please note this is subject to successfully lodging a CSHC claim within six weeks from the day their income support payment ceased.
- Indefinite cardholders, as mentioned below, who remain continuously eligible for the CSHC will also receive the energy supplement.
Retirees facing steep increases for basic living costs
Dr Martin Fahy, Chief Executive Officer of the Association of Superannuation Funds of Australia (ASFA), recently provided an update on living costs for retirees. The ASFA Retirement Standard benchmarks the annual budget needed by Australians to fund either a ‘comfortable’ or ‘modest’ standard of living in the post-work years. It is updated quarterly to reflect inflation and provides detailed budgets of what singles and couples would need to spend to support their chosen lifestyle.
What does modest and comfortable mean?
A modest retirement lifestyle is considered better than the age pension but still only able to afford fairly basic activities.
A comfortable retirement lifestyle enables an older, healthy retiree to be involved in a broad range of leisure and recreational activities and to have a good standard of living through the purchase of such things as:
private health insurance
a reasonable car
a range of electronic equipment
domestic and occasionally international holiday travel.
The June quarter 2019 figures indicate that couples aged around 65 living a comfortable retirement need to spend $61,522 per year and singles $43,601, up 0.8% for each on the previous quarter. At the modest level there was an 0.6% increase for singles and a 0.5% increase for couples.
Over the year to the June 2019 quarter, costs were up around 1.5% for couples at both the comfortable and modest levels, compared to the 1.6% increase in the All Groups CPI.
Many retirees would have welcomed the recent decision to decrease the deeming rate in the asset test for the age pension but at the same time they have been facing increased costs of living and lower returns from investments, such as term deposits. Having sufficient savings in superannuation to support the lifestyle Australians want and deserve in retirement is an imperative. Moving to 12% for the Superannuation Guarantee is a necessity for those not yet retired.
Prices that have risen substantially
However, while the increase in the headline rate of the CPI might not look large, retirees have been facing significant increases in the price of many necessities of life. The drought has impacted the prices of a range of foods, the cost of private health insurance continues to grow at around twice the general rate of inflation, and petrol prices are up.
The costs for retirees that increased substantially over the last 12 months are:
Price of bread up by 4.8%
Price of beef up by 6.0% and lamb up by 13.5%
Price of milk up by 2.9%
Price of fruit up by 4.9%
Price of vegetables up by 6.2%
Price of beer up by 2.5%
Property rates up by 2.3%
Price of hairdressing up by 2.9%
Price of private health insurance up by 3.25% on average
Price of dental services up by 2.3%
Price of domestic travel up by 3.5% and price of international travel by 4.1%
The most significant price increases in the June quarter were automotive fuel (10.2%), medical and hospital service (2.6%) and international holiday, travel and accommodation (2.7%).
The figures in each case assume that the retiree/s own their own home and relate to expenditure by the household. This can be greater than household income after income tax where there is a drawdown on capital over the period of retirement. All calculations are weekly, unless otherwise stated. Annual figure is 52.2 times the weekly figure.
Costs and summary figures can be accessed via the ASFA website. ASFA provides individual calculators to help Australians plan for retirement. Australians can find out more about superannuation on the independent Super Guru website.
This newsletter contains general advice. It does not take into account your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.