Cash Is Trash

More punishment for savers as borrowers celebrate – interest rates fall again

The recent drop in the Official Cash Rate (OCR), with suggestions from the Governor of the Reserve Bank of New Zealand (RBNZ) that it will go lower, creates a double-edged sword.

The lower OCR is great news for borrowers. However, it is woeful for those who need income from cash in the bank and for those who have a low-risk attitude to investing for the long term.

After a couple of years where interest rates looked appealing, the old saying of “cash is trash” has come back. In other words, cash left in the bank as long-term savings gives a lacklustre return versus a well-diversified investment portfolio with a higher exposure to growth investments such as shares and property.

It wasn’t so long ago the same RBNZ Governor was openly discussing steps including negative interest rates. Adrian Orr, the Governor, said before the pandemic "It is in the realm of possibility that [New Zealand] could use negative interest rates." Practically, that means negative interest on your savings in the bank, which means you would pay the bank to store your money.

While we don’t think interest rates are likely to head negative any time soon, this all does raise questions about the current path, the value of banked savings, and the monetary system.

Why Would Interest Rates Fall So Fast?

Recent moves by the RBNZ confirms it is concerned with the impact on the New Zealand economy of falling business confidence, flatlining measures of productivity, and slowing economic activity.

If you haven’t noticed, the economic pain is real.

So, interest rates are falling fast, and economic pundits and major financial institutions are forecasting they’re going to keep falling some way.  

Clearly, any measures such as negative interest rates or cash tax will be a double-whammy for anyone putting money in the bank. The other ‘whammy’ is inflation, which already eats your savings.

Money Printing (“Quantitative Easing”)

We all like to think of money as a scarce object, that needs our careful protection.

Really, the opposite is true. Money isn’t scarce at all – governments worldwide print it freely! Nowadays, they don’t even need to print it, it just takes a few clicks of a mouse and new money supply is freely created. This devalues the currency by increasing supply, which fuels inflation.

In an attempted moment of jest, Orr went viral when he joked about doing just that.

“It’s a great business to be in, central banking, you print money and people believe it.”

It is likely the people in attendance laughed because the comments are at least partially true, which is what makes any joke land. That is probably also why just one of the many videos of the comment has been viewed over 600,000 times.

Learn more: Don’t save money

Negative Real Rate of Return on Cash Savings

When you save money in a traditional savings account or term deposit, the real interest rate you earn is often quite low.

Let’s say you save money in a traditional savings account with a 4% annual interest rate. At a headline level that might sound okay, but the impact of taxes and inflation can significantly reduce what is called your real rate of return.

To break it down: if your savings earn 4% interest annually, at face value you may be happy enough. But if you are subject to a 33% tax rate on that interest (note the top rate is even higher, at 39%!) then your effective after-tax return is reduced to approximately 2.68% (since 33% of 4% is 1.32%, and 4% - 1.32% = 2.68%).

Now, we also need to consider an inflation rate of 2.5%. Inflation erodes the purchasing power of your money, meaning that even though your savings are growing nominally, their real value is decreasing. To find the real rate of return, you subtract the inflation rate from your after-tax return. In this case, 2.68% (after-tax return) - 2.5% (inflation) = 0.18%.

This means that your savings are only growing by 0.18% in real terms, which is barely keeping up with inflation.

In this case, the slightest fall in interest rates will result in a negative real rate of return, as would being in the top tax bracket of 39%.

This minimal growth, or potentially negative return, highlights why “cash is trash.” Holding large amounts of cash or keeping money in low-interest savings accounts can be detrimental to your financial health.

How Will Lower Interest Rates Impact You?

The two most obvious ways are:

1. Lower mortgage rates for borrowers, and
2. Lower interest rates for those who are saving money in the bank.

This is why we’re already seeing increasing numbers of people reach out to see if we can find them a better mortgage rate, or if we can help them get a better return on investment than what the bank offers.

The Bottom Line: Cash Is Trash

Cash is trash, and it’s likely to be even worse than trash as interest rates fall.

For wealth growth and preservation, it’s generally suggested to invest in assets like stocks (shares), bonds, real estate, or other investment options that can potentially exceed inflation rates.

If you’d like to talk with a trained professional about whether holding cash in the bank is a suitable investment choice for you, or whether something else might better meet your needs, it would be our pleasure to have a no-obligation initial consultation.