#real return

Potomac Company’s Bonds for $1 Only

Potomac Company bonds: The Potomac Company’s bonds have a face value of $1,000, will mature in 20 years, and carry a coupon rate of 16 percent. Assume interest payments are made semiannually. Determine the present value of the bond’s cash flows if the required rate of return is 15 percent.

Find the real return on the following investments:

Stock…

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In May 2015, the Reserve Bank of Australia dropped the official cash rate to 2.00%.  This is the lowest interest rates have ever been in Australia.  If you are a borrower, then times are good, paying off debt has never been easier. Even though banks have not passed on the full rate cuts on mortgages 

If you are a saver, then times aren't so good, returns on savings have never been worse.  Many Australian savers are asking 'How can I get a decent return on my savings?'

Today, The Finance Guy will have a streetonomic look at savings rates in Australia since the GFC.  We want to find out how Australians can achieve a decent interest rate on their savings.  We will look at:

The RBA Rate Since the GFC

What is CPI, and How Does it Impact My Savings?

What Rate Can I Get on My Savings?

Is There a Smarter Way to Save?

Why We Like the Fund

What Are the Investment Options?

A Special Offer For TFG Readers

The RBA Rate Since the GFC

Interest Rates in Australia have been falling since 2008, as shown below:

A timeline of the GFC, shows that the trouble began in August 2007, when alarm bells started ringing in the US debt market. Australia was enjoying the mining boom, and our cash rate was on the rise. It wasn't until 12 months later, and the collapse of Bear Sterns that the RBA started cutting rates.  

In the past 7 years, Australians have seen the RBA cash rate fall from 7.25% in September 2008, to the current 2.00% reached in May 2015.  This is a drop of 525 basis points, or 72.41%. Once you consider inflation, Aussies trying to build up their savings, or self fund their retirements,  are having a tough time achieving a real rate of return on their savings. 

What is CPI and How Does it Impact My Savings?

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The Consumer Price Index (CPI), is used to measure inflation.  It is expressed as an annual percentage which shows how much much prices have changed over the previous 12 months.   Inflation caused your money to lose purchasing power.  As prices go up, your money can purchase less goods and services.  According to the Australian Bureau of Statistics, the CPI to the march quarter of 2015 was 1.30%.  In other words, for every $100 you had one year ago, you'd need $101.30 in order to maintain your purchasing power.

When you are holding cash, it is important to pay attention to inflation.  If your money is not keeping up with inflation, then it is effectively losing value over time. When looking at savings options, the rate quoted by the bank is known as the 'nominal rate'.  This is the amount you will earn.  To see how your savings are really performing, you need to subtract inflation form this to find the real rate of return.

What Rate Can I Get On My Savings?

We conducted a brief internet search to see what interest rates are currently on offer from banks.  We looked at three savings types:

Term Deposit Rates for $10,000

At Call Savings Rates for $10,000

Returns for SMSF Term Deposits of $100,000

The results of our uncomprehensive study, are shown below:

As expected, the interest rates available are less than spectacular.  Once we adjust for inflation, things look even worse.  To get a real return above 2.00%, a SMSF would need to look in their funds for at least 3 years.  If they need access to their money during this time, their interest will be adjusted down as a penalty for breaking the term.  On the upside, the bank has committed to paying you this rate so even if rates fall further, your savings will earn this rate for the duration of the term deposit.

For individuals, the best rate of return  is found with an at call savings than with a term deposit.  This does however come with the condition that you make a minimum deposit each month, and no withdrawals.  If you fail to make the full deposit, or take any money out of your account, your interest for that month will drop substantially.  This rate is variable and subject to change without notice.

The cash rates we found above come with one very important feature, which makes the a popular choice for savers.  Your Funds are Deposited with a Bank and are protected by the Australian Government Guarantee Scheme.  This makes cash a capital secure asset class.  While your returns might be conservative, there is no risk that you will be left with less money at the time you close your investment.

Is There a Smarter Way to Save?

To get better returns on your savings, we think you need to invest some of your savings outside of cash.  We looked at investment opportunities in the fixed income asset class, and found Smarter Money Investments, who offer two funds which have the potential to give your savings a healthy boost.

They offer two unit trusts, which give investors, a potential return of up to 4.20%  as well as access to their savings within 3 business days. There are no penalties if you make a withdrawal, and there is no obligation to make ongoing deposits. You can open your investment with a deposit of AUD $1,000, and can add more funds at any time through either BPay or an EFT transfer.  That's 20% Better than the best rates the banks are paying! 

It Sounds Too Good to be True, What's the Catch There is no such thing as a risk free return. Here at The Finance Guy, we understand the relationship between risk and return The potential for better returns is always accompanied by an increase in financial risk. You can earn a better return on your savings, but you will need to accept additional risks

What Are the Risks?

It Sounds Too Good to be True, What's the Catch There is no such thing as a risk free return. Here at The Finance Guy, we understand the relationship between risk and return The potential for better returns is always accompanied by an increase in financial risk. You can earn a better return on your savings, but you will need to accept additional risks

There is no Government Guarantee When you put your savings in Smarter Money, you are making an investment in a unit trust. This is not a cash deposit, and your capital is not protected by the government in the same way that a cash deposit with a bank is. Here at The Finance Guy, it is our opinion that the probability of Smarter Money experiencing losses is low, but it is not an impossibility. There is a possibility that you can lose your investment!

Market Risk Smarter Money will invest in wholesale markets for bonds, fixed interest and cash deposits. Their ability to generate returns for investors, depends upon the avaialability of suitable investments in the open market. If market conditions deteriorate, then this will be reflected by a fall in returns delivered by the funds Returns are not guaranteed

Regulatory Risk Financial markets and political systems are relatively stable in Australia. If Australia experiences any changes in these systems, then this may alter the ability of the fund to invest your money, or to provide you with access to funds already deposited. Bank deposits are also exposed to regulatory risk, but not to the same extent of a unit trust.

Delegation Risk An investment in a unit trust is a leap of faith. You are allowing someone else to make your investment decisions for you. Robert Kiyosaki would tell you that Rich Dad's Delegate. The Finance Guy is a dad, but has trouble delegating. If you invest with Smarter Money, you will not have control over how your savings are invested

Why We Like the Fund

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We acknowledge that this investment is riskier than cash, and comes with higher risks.  We are willing to accept these risks, because as the saying goes 'No Risk, No Reward'.  In our view, the potential for higher returns outweighs the added risk because Smarter Money offers:

A Sound Investment Strategy Smarter Money invests in cash and fixed interest.  There is nothing overly fancy going on.  Your money will be invested in a combination of term deposits, and debt securities.  By investing in bonds, you are lending your money to whoever issues the bond.  This could be a corporate entity such as a bank, or it could even be the Australian Government.  These investments are riskier than cash, but less risky than other asset classes such as equity or derivatives.

Access to Wholesale Returns Smarter Money has approximately AUD $550 Million under management.  This gives them more negotiating power than the average retiree with a super fund.  When you invest in the fund, your funds are pooled with those of fellow investors.  Together, you can invest larger amounts, and negotiate better returns.  

Liquidity Within 3 Business Days If you need access to your savings, you can request a withdrawal and have your money within 3 business days.  There are no exit fees, and there are interest penalties applied.  If you are saving for a particular purpose, such as to buy a house, it's good to know that in the event that you need your funds, you can access them in a timely money

Flexibility As we noted earlier, Smarter Money allows you to make additional deposits at will through BPay or an EFT.  You can also set up a regular savings plan if you choose to.  You also have the choice to choose what happens to your quarterly earnings.  You can either have them reinvested back into the fund, or paid out to an account of your choice.  You have the option to either build an income stream, or keep your savings growing.

What Are the Investment Options

Smarter money offers two unit trusts, which The Finance Guy, thinks are great savings options. He has so much faith that he convinced The Finance Wife, to invest her lump sum of cash with Smarter money.  Smarter Money offers two investment options.

The Smarter Money Active Cash Fund   The SMAC Fund currently has approximately AUD $300 Million under management. The fund invests in a combination of cash and fixed interest.   The SMAC has been rated 'Very Low Risk'.  Since inception in February 2012, the Active Cash Fund has consistently outperformed the target rate. The May 2015 Performance Report shows an annual gross running yield of 3.90% after all fees. For more information please refer to the Smarter Money Active Cash Product Disclosure Statment

The Smarter Money Higher Income Fund The SMHI Fund has approximately AUD $220 Million under management.  The fund invests solely in fixed income investments.  The SMHI has been rated 'low to medium risk'.  Since inception in August 2014, the fund has outperformed the target rate. The May 2015 Performance Report, shows an annual gross running yield of 4.20% after all fees.  For more information, please refer to the Smarter Money Higher Income Fund Product Disclosure Statement

A Special Offer for TFG Readers

Here at The Finance Guy one of our priorities is minimization of investment fees. We don't expect fund managers to work for free, but their fees dilute our returns, so lower fees means a better return on investment.  As a member of the Australian Financial Services community, The Finance Guy is able to reduce administration fees and offer a 0.20% fee reduction to all our readers.  

If you are located in Australia, and would like more information, please fill in the form below, and we will arrange for an authorised adviser  to contact you promptly.

General Advice Warning The content in this post, and on our entire website, should be considered as general in nature.  We have not taken into consideration any of your personal circumstances, and can not say whether or not the products we discussed are appropriate to suit your personal financial needs.