Drastic cuts by the Reserve Bank have sent interest rates crashing to record low levels, and they’re only expected to get lower in the foreseeable future. It’s great news for mortgage-holders — but, writes Martin North, retirees relying on term deposits have been forgotten.

Believeit or not, bank deposit rates on term deposits in Australia have halved since 2018. And with the RBA expected to cut their cash rate again soon, this will get worse — much worse.

The truth is, as rates are cut to try to stimulate the fading economy, everyone tends to focus on ever cheaper mortgages, forgetting the 3 million households — many older and retired — who rely on regular income from deposit account savings. In effect, they have taken a massive pay cut. They are a silent minority.

Even before the RBA’s cash rate cuts in 2019, banks started to cut deposit account rates, as they attempted to bolster their profits and sharpen their lending rates in an ever more competitive environment. And as the RBA then joined the rate cut party, interest rates dropped to below 2 per cent, or worse, for many.

This is not a short-term reversible trend. I expect more RBA cuts ahead, and the recent bushfires makes it even more likely. We are belatedly following the trajectory of economies like the UK and Germany, where rates have been lower for longer than expected for a decade, since the financial crisis of 2008. So we must plan on rates remaining low, and going lower, for years. In fact, deposit rates will likely be below inflation, which means in real terms you are already going backwards.

This is not a short-term reversible trend. I expect more RBA cuts ahead, and the recent bushfires make it even more likely.

Households that rely on income from deposits often have limited alternatives and are therefore uniquely exposed, compared with households in paid employment.

We survey a range of households through the year, and they have seen their incomes drop by up to half. But more than half of those with funds on deposit said they do not intend to switch their hard-earned savings to the more risky environment of stocks, shares, bonds or property. Rather, they will simply hunker down, spend less and save more. This is one of the main reasons why retailers are feeling the pinch — households are not able to spend. Worse, they are having to eat into their capital, meaning their future resources are being diminished.

Other households are taking more desperate steps. Some are moving into higher-risk investment options, including speculation on crypto currencies like Bitcoin, buying into the share market (despite the inflated prices now and lower expected returns ahead), or considering other higher-risk solutions. But our surveys also suggest that many do not appreciate the risks they are taking and that, in a crisis, they may lose capital.

Another factor in the mix is that the so-called ‘deeming rate’, which is used to estimate the effective rate of return on deposits, is significantly higher than it is in reality. So access to government benefits are being restricted by this mismatch. The deeming rate dropped last year but it is still well above today’s actual rates, and as rates drop further people will be hit harder.

I believe the government should be considering the development of a new government-backed saving scheme that pays a reasonable return. This would enable savers to maintain their income levels, and act as a signal to the market that ever lower savings rates are not acceptable. This would be analogous to the National Savings Scheme in the UK. However, I suspect we are on our own and so households that are seeing their savings returns dropping need to make some tough decisions.

First, decide whether the expected returns on lower savings rates ahead will lead to cash flow problems. This involves drawing up a cash flow — ASIC’s MoneySmart website has some useful tools.

If you are able to survive at the lower rates (even by cutting back) and do not want to take on more risk, then seeking the best deposit rates via comparison sites is a good move. We often find the ‘big four’ offer the worst rates, so shop around.

We often find the ‘big four’ offer the worst rates, so shop around.

But if your cash flow suggests the lower rates will just not provide enough income, you may have to revert to living off your capital. But this may not be sustainable over the longer term, because as the capital is reduced so is the income on that capital.

Alternatively, you will need to seek out higher-yielding options, but there is no one simple solution, as it will depend on your risk threshold (remember that markets can fall). Some bonds offer better returns with more certainty — assuming the entity issuing the bond survives — but there are still risks involved. You also need to consider fees and charges, as these often eat into the value of the investment and are not always fully disclosed.

Finally, beware of superficially attractive higher-rate offers from online, or in the newspapers. High returns signal, at best, high risk. And at worst, fraud.

This is the prisoner’s dilemma that many deposit holders now face. Welcome to low-rate city.

Martin North is the Principal of Digital Finance Analytics, a boutique research and analysis company. Seek advice from a professional before making any important financial decisions.