Debt – Financially Wise

No Interest – Our record low interest rates

Most eyes and attention were on the federal treasurer on 3^rd May as the budget was brought down. But being the first Tuesday of the month, the Board of the Reserve Bank of Australia also met. After many months of leaving official interest rates steady, they made the decision to cut them this month. What does that mean for you?

The majority of people don’t worry about interest rates other than how it impacts on them. Many people don’t really give much thought to the rise and fall of interest rates and the reasons behind them.

But the world’s central bankers usually only cut interest rates when they think their economies need a boost. In other words, when a country’s economy is tanking, a central bank may cut interest rates to try and stimulate demand.

The thinking behind this is that if credit is cheaper, people might be more inclined to borrow. Preferably, they’d like them to borrow a larger amount than they might otherwise have borrowed if interest rates were higher. Our economies are not growing if debt is not increasing.

But because lower interest rates are associated with lower economic growth, this also has the effect of lowering confidence in the markets and the economy, even if it is at a subconscious level. It is worth remembering that we are now well below the so called “emergency” interest rate level we were at during the GFC. This means that lowering rates is likely to have the opposite effect than was intended by the Reserve Bank. All that negative interest rates do is confirm that our economies are in grave trouble and reduce overall confidence in our economies.

In addition lower interest rates are not good news for those who save or people who rely on income from cash deposits, whose incomes have just dropped yet again. Ironically, while low interest rates benefit those who already have mortgages and other loans, it hurts those who are actually saving for a home or other big ticket item, thus keeping them from borrowing sooner than they might with higher interest rates. It also means that people who rely on interest for income have less to spend, thus contributing less into the economy.

There is also the law of diminishing returns, in that each subsequent interest rate cut has less effect and the impact of the cut has a shorter actual duration. So any possible benefits this cut might have had will last a shorter time and be less effective than the last round of rate cuts, until they lose all effectiveness.

It brings to mind Einstein’s definition of insanity. Doing the same thing over and over and expecting a different result. This cut will not be any different. If the last dozen or so cuts that we have had have not had the required result of stimulating the economy, why will this one be any different?

Japan, Sweden and Switzerland currently have a negative interest rate policy (NIRP) and countries like Europe and until recently, the US have zero interest rate policies, based on this very assumption that it will stimulate the economy and increase demand.

It’s not working. For example, in Japan, more people are saving and hoarding cash the lower interest rates go, especially when they go into negative territory. If these zero or negative interest rate policies were effective at all, these countries would have booming economies. They don’t.

The world is already awash with debt. Trying to solve a debt problem with more debt by lowering interest rates will not work, particularly when a lot of that debt is tied up in non-productive assets that do nothing to make a real contribution to the economy.

Given the sluggish nature of global economies and the uncertainty of our own, now might not be the time to be getting further into debt, as attractive as the low interest rates might be.

Here are some things to consider in a low interest rate environment:

Pay off debts: Instead of racking up more debt, use the low interest to pay off debts instead.
Look for better rates for debts: Use the low interest rate as an opportunity to negotiate a lower rate on the debts you do have. Home loans are a good place to start, but also look at other loans and credit cards. Maybe consolidating them all into one low interest rate loan can help.
Start saving or boost existing savings: If you have low or no debt, think about channeling more money into savings. This can then be directed into investments.
Search for yield: Lower interest rates mean it can be a struggle to obtain a reasonable interest rate on your savings, but there are tools available to help you find those higher interest bearing accounts. Websites such as Canstar, Finder and others, for example, can help you search for and compare various bank accounts for higher interest rates. Be aware though that these websites may not list all banks or accounts available and always read the terms and conditions. These sites can also be useful for finding low interest rates for loans as well.
Take advantage of low interest rates if necessary: Conversely, while it might not actually be the best time to take on more debt, if your car or a big ticket item is long overdue for replacement, there might be no better time to use low interest to your advantage. However, try to make extra payments to pay this off as soon as possible, rather than just make the minimum repayments.

Lower interest rates might make it tempting to borrow more money than you normally would, or get further into debt, but warned this may be a trap. It can be easy to become overextended should interest rates rise.

It is unlikely that official interest rates will rise soon, but that doesn’t mean that the banks won’t raise interest rates outside of the official interest rate. Banks obtain a percentage of their loan funds from overseas and are reliant on Australia maintaining its AAA credit rating and confidence in Australia’s economy. Banks are also reliant on depositor’s money to provide the balance of their loan funds. They are unlikely to attract too many depositors if interest rates are too low.

But most importantly, think about why interest rates are being lowered by the RBA. It’s a sign the economy might not be doing as well as many people suppose. Some businesses might not be financially sound due to slower economic conditions and the threat of closure is ever present. If your job is your only source of income, how well could you pay back your loans if you lost your job?

New Year, New Money Habits

As January makes its way into February, it must catch some people by surprise at how quickly the year is passing. How many people set themselves New Year’s resolutions at the start of the year? How many people are sticking to their resolutions and how many have already broken theirs? How many made resolutions to get their finances under control, but are still struggling?

Getting finances in order is one of the most common New Year’s resolutions.

People routinely start the year intending to save more money, pay down debt or to start investing or a combination of these.

But unless they can define what it is they want and have a solid plan in place, it can be easy to let old habits take over and then they’re back to square one and nothing is achieved.

It’s time to give this some thought and put practices and habits in place so you end the year better off financially than how you started it.

Firstly, be clear and know what the end goal is and what the outcome is that you want to achieve.

If you are saving, what is it you are saving for, a house, a car, a holiday or just to have some spare emergency cash?

If you want to pay off your debts, what are they, how many are there, how much extra can you contribute towards paying them off and can you avoid adding more debts?

If you want to start investing, for what is it going to be? If for retirement, how long have you got until then, and are you a risk taker or risk averse? How much can you put aside regularly to invest? Are you prepared for the risk?

When your goals are more defined, your path and the definite actions you need to take also become clearer.

Here are some tips on getting finances in order:

Saving: Set up a separate not easily accessed account and regularly transfer either a percentage of all income or a fixed amount into it.
Reduce or pay off debts: Write a list of all your debts. Work out how much extra can be put towards your debts. Choose the one you intend to pay off first and put the extra amount towards this debt until it’s been repaid. Do the same with the next debt.
Start investing: Are you a risk taker or risk averse? If you don’t like the volatility of the stock market and don’t want the responsibility of being a landlord, or you don’t have a lot to invest you might want to start with a property or equity trust into which you make regular contributions.
Have a plan: What amount do you need to save? What are your total debt repayments? How much will you need to retire? How can you make adjustments without compromising your lifestyle too much? If you answer these at least you will have a figure you know you need to work toward. Break this figure down to annual, quarterly, monthly and then weekly amounts.

Meeting your financial goals should not be a difficult or time consuming task. If you keep it simple you’re more likely to attain it.

You will also be more likely to be successful if what you want to achieve is congruent or resonates with you. If you’re working towards something that you really want, then there’s more incentive for you to continue along the new path you have chosen for this year.

Persist with it, as it’s worth it when you have saved the amount you need for your special purchase, you no longer have any debts to worry about, your financial future now looks more secure or you have achieved your financial goal. That’s a great feeling and one New Year’s resolution you kept and achieved.

But the best news is that this doesn’t have to be a New Year’s resolution, you can start it at any time you like, whenever it suits you.

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Get organised for Christmas NOW

This may not be what people, especially parents, want to hear just after the September/October school holidays – but it’s best to start budgeting for Christmas, which is now less than three months away.

Christmas could be a stressful time for some people’s budgets, and hip pockets if you don’t prepare yourself for it and give yourself enough time.

Many people, especially parents with younger children, could easily overspend and exceed their budget during the Christmas season if they didn’t plan for it early enough.

If you leave it until the last minute you could end up putting most or all your Christmas purchases on credit card and then suffer from bill shock when the statement arrives in January.

Quite often your ‘friendly’ bank will offer you a holiday reprieve by allowing you to defer for a month the repayment that would normally be due in January.

But don’t be fooled, that ‘bill holiday’ will cost you more in interest and the bank is not doing this to be nice, it will end up as more profit for them.

This is made worse if the whole balance is not paid off at the end of each month; you end up paying interest on your interest. For many people, this is a reality, with many people carrying credit card debt for many years, in some cases long after the item originally purchased has broken or stopped working and been thrown away.

So, ideally, the earlier you start planning for events like Christmas and even birthdays and anniversaries, the better. But with a bit of planning and saving, it’s not too late to get control of your finances for Christmas.

Here are some tips to help you prepare now for Christmas spending:

Prepare lists of what you need to buy: That includes gifts, food and entertainment, postage for gifts and cards as well as tree decorations and holiday plans.
Budget for the costs: Work out the costs of these items to give you a total amount as a guide and add five to 10 per cent for unexpected expenses.
Put money aside: Work out how many pay days you have left until Christmas and then divide your expenses by days – now try to save that much each pay, preferably into a separate or Christmas account.
Sales: Take advantage of sales – if you see an item from one of your Christmas lists on special, buy it when you can.

An alarming number of Australians have an even more alarming amount of debt. A lot of debt is tied up in housing, or so called “good debt”, which is a large risk in itself, should property prices start to head downward.

But a large amount of debt is also consumer debt, or so called “bad debt”, which is also worrisome.

Debt levels have reached record highs with the Australian Bureau of Statistics reporting that Australian personal debt levels are now just under $1.8 trillion for the country – or nearly $80,000 for every Australian.

A recent Barclays survey lists Australian households amongst the most indebted in the world.

It would be good to remember that all or any debt, whether good or bad debt, is a claim on future income for today’s consumption.

If you don’t have a buffer in place or allow for adverse instances should circumstances change, you can be caught short and have to make quick financial decisions which could have devastating consequences and impact you for many years.

Christmas presents

Zero interest rate policy is a disaster

It is, quite frankly, astonishing how the world’s economies and markets reacted recently to the possibility that the US Federal Reserve MIGHT, and that’s the key word here, MIGHT, have raised interest rates during September.

Stocks and commodity prices crashed and volatility increased massively at the possibility of a ONE QUARTER OF ONE PERCENT official interest rate rise by the US central bank.

Seriously!?! Are the world’s economies so fragile, that the thought of a 0.25 interest rate rise in the US sends everything and everyone into a tailspin?

This is what happens when official interest rates are kept too low for too long. The world has come to rely on cheap credit to keep it going. If it is to be used at all (and I don’t think any central bank should ever artificially lower interest rates to stimulate an economy), it should only be used sparingly for a very short period of time.

Now, because it’s become so cheap to borrow money, global debt levels are at record highs, even high than before the GFC. Because investors cannot get a decent return on their cash, they move into riskier and riskier “investments” to try and get a yield, quite often using borrowed money, because after all, it’s cheap to borrow.

It doesn’t help any that quite often this borrowed cheap money wasn’t actually put to productive good use, it was instead used to buy back shares, boost director salaries and bonuses in the case of listed companies, or used for dubious and speculative ventures by others.

It has now been seven years since the GFC and interest rates are still incredibly low, or effectively at zero or even negative in some countries when inflation is taken into account, and they are still at “emergency” levels.

Shouldn’t it be patently obvious by now that the zero interest rate policy (ZIRP) or ultra low interest rates don’t work? Neither does stimulus, money printing, quantitative easing or whatever you want to call it, which was only possible due to these low interest rates.

Einstein has been credited with saying that the definition of insanity is doing the same thing over and over and expecting a different result.

Central banks think they can control an entire economy and get it to do what it wants. So it keeps cutting interest rates, and then when the short term boost it provides wears off, they cut them again. And again. And again.

But due to the law of diminishing returns, each interest rate cut has shorter and shorter impacts, until it doesn’t have any more effect.

And our central banks sit there wondering what more they can do, not realising they are one of the major contributors to the problem. And we look to them to fix the problem that THEY helped create in the first place.

Now THAT is insanity!