Financial planners should be advising retiree clients dependent on cash investment income to move away from traditional investment models and look for alternative sources of income during the current low interest rate environment.
Schroders deputy head of fixed income Stuart Dear said the commonly used ‘bucket strategy’, in which investments are allocated to three asset buckets – equities, diversified but defensive, and cash – was not applicable during times of low interest rates.
“As the income and capital from the cash bucket is used for day-to-day expenses, the income generated by the riskier buckets flows down to top up the cash bucket. With significantly lower return on cash, there is clearly a problem with this model,” Dear said.
“With official interest rates remaining at a record low of 0.75 per cent following the latest RBA (Reserve Bank of Australia) board meeting, it is now a serious challenge for investors to generate income using traditional approaches. This problem is compounded further on platforms where the rate paid to investors for cash accounts is nearing zero after fees.
“Furthermore, while 1 per cent has commonly been seen as an effective floor for the cash rate in Australia, we think rates can go lower still, even to zero, given the global experience. And it’s likely that cash rates will be kept at low levels for a considerable period of time, exacerbating the challenges facing retirees, and indeed any investors, seeking the benefits of cash.”
He said given these circumstances, retirees had to rethink the bucket strategy and consider changes to the make-up of their cash investments to generate greater returns, adding a diversified and defensively oriented fixed income strategy that also offered periodic income and daily liquidity could be a good substitute for part of a cash investment strategy.
Alternative options to cash may involve higher levels of risk, but a fixed income strategy made up of high-quality, liquid, publicly traded securities offered the liquidity and certainty of returns found in cash investments, he pointed out.
Another way forward for retirees was to subdivide cash investments into three segments, based on time frames over the next three years, in which the investments had differing levels of liquidity and certainty of return, he said.
He said during the shortest time frame, of up to 12 months, “investors want the greatest certainty and liquidity, therefore [investments] may be best maintained as cash investments”.
Looking out to one to two years, “investors can take a little more risk to invest for slightly higher returns”, he said.
“However, this allocation away from cash should only be into defensively oriented strategies with high liquidity, and cash should still be a large part of this segment,” he noted.
For the two to three-year time frame, he said: “This segment can take more risk again and this is where it may make sense to blend some of the higher-risk options, alongside cash and more defensive options.
“Based on this strategy, investors would still hold a little over half of their cash bucket in cash, but also utilise fixed income to lift their income generation without unnecessarily compromising the certainty of capital and liquidity requirements.”