Negative rates of return

Negative real rate of return for term deposits

Is the real rate of return on term deposits already negative?

Interest rates are at record lows and have been falling for some time now. This is good for first home buyers (who can expect low interest rates, which helps them gain homeownership by reducing the regular mortgage repayment required), but has a bad impact on those keeping significant sums of cash in the bank without good reason.

So, how bad have things got for savers? To answer, let’s first look at something called ‘real rate of return’…

Real rate of return – what is it?

Real rate of return is the annual percentage of profit earned on an investment, adjusted for inflation. Therefore, the real rate of return accurately indicates the true purchasing power of a sum of money over time.

What is inflation?

Inflation is the term used to describe a steady increase in average prices throughout the economy. It means that money is steadily losing its value in real terms.

Even the Reserve Bank of New Zealand refers to inflation as the “thief in your wallet”, and it provides a handy calculator to help explain how the real value of a NZ Dollar has changed over time. For example, if you were earning $50,000 in wages in 1979, that would be the equivalent of earning nearly $350,000 in late 2019!

The maths is terrible for savers

The average 12-month term deposit on offer at major NZ banks has dropped to around 2.50%.

Unfortunately, term deposits are one of the most highly taxed sources of income. They’re taxed at your Resident Withholding Tax (RWT) rate. RWT rates differ depending on how much you earn, which includes NZ Superannuation (“the pension”) if you’re over 65:

  • $14,000 or less = 10.5% tax
  • $14,001 to $48,000 = 17.5% tax
  • $48,001 to $70,000 = 30% tax
  • over $70,000 = 33% tax

Inflation is the next thing to consider, which is currently reported to be 1.90% each year.

Inflation - the thief in your wallet
Inflation: the thief in your wallet

Negative real rate of return

So, let’s work through a quick example to calculate the real rate of return on a 12-month term deposit:

  • 2.50% interest from the bank
  • Minus 30% tax (this is the tax rate for a NZ employee earning an average wage) =
  • 1.75% after-tax return
  • Minus inflation of 1.90% =
  • -0.15% real rate of return. Yes, you read that correctly, it’s negative! This means anyone paying 30% RWT on term deposits is going backward financially.

Or, if you’re paying 17.5% RWT (which is the rate that most retirees pay) you might achieve an after-tax return of:

  • 2.0625% after-tax (to keep it simple let’s round that to 2.06%)
  • Minus inflation of 1.90% =
  • 0.16% real rate of return. While your real rate of return is positive, before celebrating too much keep in mind that you’ll have to keep $100,000 locked into a term deposit for a full year to earn a real return of $160!

But wait, there’s more

NZ’s main commercial banks (ANZ, Westpac, etc.) closely watch interest rate movements and have teams of employees with a lot of brainpower who try to predict upcoming interest rate changes. All of NZ’s main banks now expect NZ interest rates to be cut again by the end of March 2020. Longer term trends don’t look much different, as interest rates in NZ are high when compared with most other developed countries. For example:

  • Our rate is double that of Australia (who cut their rates a few days ago) and higher than the UK,
  • The whole European Union (EU) is at 0%,
  • While the US has rates slightly higher than ours, they just made a cut,
  • Countries including Israel, Sweden and Denmark, are at or near 0%, and
  • Several other countries have negative interest rates, including Switzerland and the powerhouse economy of Japan.

What can you do?

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