Your mattress is not an investment choice

Warren Buffet's grandfather gave his adult children $1,000 on their tenth wedding anniversary, recommending that "everyone should have a reserve"¹.  In today's context, that would equate to tucking away one-third of the average annual Australian wage.

Having a reserve, never appeared wiser than today. However, a headlong dash to cash may provide false certainty for investors with longer-term financial goals. Doing nothing can be equally unhelpful. It may be time for investors to make choices that provide room to adapt to changing economic conditions.

Liquidity before cash

Setting aside some rainy-day money never goes out of fashion.

In modern finance, liquidity, or the ability to access cash flow, is the muscle behind cash's throne. Today, financial liquidity takes many forms. Money in the bank and government bonds are two examples. And in today’s low-interest rates, access to a line of credit may be a suitable source of financial liquidity for some investors.

Confident Flexibility

Credit cards and personal loans provide quick access to cash but don't tick the low-interest rate box. Some borrowers recently learnt the critical difference between a home loan redraw facility and an offset account. If at the time you most need liquidity the bank can withdraw your redraw facility, then it is not real liquidity.

During normal conditions, one type of loan can look much the same as another and comparing loans on interest rates and fees seems reasonable. But the loan terms and conditions small print matter.

The real measure of a credit facility is how it operates during unusual or unexpected conditions; what rights and obligations switch on or off during those times. On that measure, a margin loan is the best overall facility for suitable investors who want to borrow to buy equities or rebalance an existing portfolio to ensure it continues to match their investment goals in a revised market outlook.

Confident Preparedness

After preparing for investment opportunities by establishing flexible access to real liquidity, investors need to think about how they will borrow. The Reserve Bank of Australia's policy is not to increase interest rates until Australia is 'making sustainable progress towards our goals for full employment and inflation’². With that view, fixing and prepaying interest appears counterintuitive.

The ability to electronically access any account or facility on the go at any time, can make it seem like we are drawing financial liquidity from the one well. But the source of the cash flow makes a difference when other factors, such as taxation are considered for most typical personal investors.

Fixing the borrowing cost, gives budgeting certainty and the confidence that liquidity can't unreasonably evaporate. Prepaying interest may make it easier for suitable investors to manage across different sources of financial liquidity and be better equipped to make effective investment decisions.

If your clients would like to fix and prepay interest on their loan account before June 30, please get in touch with your Relationship Manager or call on 1300 307 807.

This information is correct as at 1 June 2020.

Source

¹ https://lettersofnote.com/2011/10/12/everyone-should-have-a-reserve/
² An Economic and Financial Update, Philip Lowe, Governor Reserve Bank of Australia 21 April 20