Does low interest = excessive risk?

15 October 2015

Does a low interest rate environment equate to excessive risk-taking among savers seeking a healthy return on their money? It’s not unreasonable to think so; the official cash rate is stuck at just two percent, and currently on Canstar’s database, the highest 12 month term deposit (for $50,000) is just 2.95 percent.

With inflation of 1.50 percent and the most common marginal tax rate being 34.5 percent (including Medicare levy), many investors are lucky to break even.

What cash return do you need to break even?

Based on the above inflation, the return that you need in order to break even on your money is as follows:

Marginal tax rate Inflation Return to break even
21.00% 1.70% 1.90%
34.50% 1.70% 2.29%
39.00% 1.70% 2.46%
47.00% 1.70% 2.94%

With a 12 month term deposit interest rate high of 2.95%, those on the highest marginal tax rate are barely scraping a net return.


Are we taking more investment risk?

Given the fairly depressing net returns above, are we inclined to take a greater investment risk with our money? The recent conclusion from John Simon, RBA Head of Economic Research, was no. He concluded that “while there are grounds to be concerned, there are also reasons to think that there may be an excessive degree of sensitivity about anything that looks remotely like the financial crisis.”

“In sum, in 2007 we experienced a combination of factors that each contributed to the financial crisis. The world economy was growing strongly, but contained inflation led many central banks to keep interest rates low. In some economies prudential regulation was clearly inadequate to contain a deregulated banking sector. Together, these contributed to a highly leveraged financial sector. And the rest, as they say, is history.

This of course leads to another observation – in many advanced economies with low interest rates these other conditions are not apparent at the moment. Economic growth is weak, credit growth is generally low, there are many people paying down debt and not many investing – we could probably do with a bit more entrepreneurial risk-taking.”

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