With inflation easing here in New Zealand and around the world, interest rates and term deposit rates are noticeably lower. So, what does this mean for your money?

Why interest rates and inflation matter

Interest rates and inflation both play important roles in the economy and can directly impact your investments. Think of interest rates like the price of borrowing money. When rates go down, it’s cheaper for everyone to borrow – from homeowners with mortgages to businesses looking to expand. While this might sound great if you have a mortgage, it can mean earning less interest on your savings accounts and term deposits.

Term deposit rates decline with interest rates

As interest rates decrease, savings and term deposit rates typically follow suit. This leads to lower earnings from these accounts, often prompting investors to consider alternatives that offer potentially higher returns.

Why managed funds might appeal

Many investors turn to managed funds with the aim of earning better potential returns over the long term. Managed funds allow you to pool your money with other people to access a wide range of investments – all managed by professionals who do the investing for you. If this sounds familiar, it’s probably because many New Zealanders already access managed funds through KiwiSaver (a prominent type of managed fund).

You may like to consider whether investing in managed funds alongside your KiwiSaver account could suit your individual goals. Here’s why:

• Flexibility
  While many managed funds have a suggested minimum investment timeframe of several years, you’re generally not locked in for a fixed term. This means you can usually withdraw or adjust your investments if you need to.
• Broad mix of assets managed by experts
  Managed funds typically invest in a variety of assets, such as shares, bonds, and property. Your money is invested under the guidance of specialist fund managers, across different industries and locations.
• Opportunity for long-term growth
  Managed funds could help make your money work harder for you. They may lead to better potential returns over time (when compared with a traditional savings account), and could offer a way of protecting your money from the negative impacts of inflation.
• Potential savings on tax
  Managed funds are usually portfolio investment entity (PIEs), and returns are taxed at a maximum of 28%. You’ll be taxed at your prescribed investor rate (PIR) instead of your personal income tax rate. So, if you pay income tax at the top rates of 30%, 33%, or 39% you’ll pay less tax on your PIE returns because the maximum tax rate is 28%.
• Range of options
  Managed funds come with different risk profiles, from conservative through to growth and high growth options. The investment mix of growth and income assets in a fund affects its level of risk and potential returns. Growth assets (usually shares) are higher risk, and income assets (usually bonds) are lower risk. Understanding your attitude to risk and your investment timeframe is key to finding the right option for you.

Tailoring your investments to your goals

Whether you’re reviewing your KiwiSaver account or looking to invest in managed funds, it’s important to consider your investment timeframe and the amount of risk you’re willing to take.

If you have a long-time horizon

Younger investors or those saving for retirement may be able to take on more risk, for example with a growth or high growth option. Though you’ll see more market fluctuations, you also have more time to recover from any dips.

If you’re buying a home soon

If you plan to use your savings for a home deposit in the next three to five years, a more conservative approach could help protect you from short-term market swings. Conservative funds generally aim to provide relatively stable returns over the short to medium term.

If you’re nearing retirement

For over 65s, KiwiSaver provides a way to keep saving with lots of flexibility around contributions and access. There’s a common misconception that you need to withdraw all of your savings when you turn 65, but that’s not the case. However, if you’re close to making a full withdrawal for retirement, you might want to consider taking less risk, to help safeguard your savings against any significant market downturns.

Keeping perspective in a changing rate environment

Here are three tips to consider when interest rates are dropping.

1. Understand your savings and investments
   Take the time to review how your money is currently allocated, and consider whether this aligns with your investment timeframe and comfort with risk.
2. Focus on the bigger picture
   While interest rate changes are one factor to consider, it’s a good idea to take into account your long-term investments, along with your overall financial goals and circumstances.
3. Stay informed
   Consider reviewing your financial situation at regular intervals – such as once a year, or when your circumstances change – to assess whether adjustments are needed to align with your long-term goals.

The bottom line

Lower interest rates can affect everything from term deposit rates to share prices. However, no one approach to investing is right for everyone. It’s about choosing the investment line up that best fits your goals, timeline, and tolerance for risk. Making informed decisions based on your investment goals can help keep your money working for you through all kinds of market conditions.