Are you ready for a fall in income?

Income investors have got it pretty good at the moment.

With interest rates at the highest level in 15 years, it’s become much easier to make a steady, reliable income on your savings.

With a six-month term deposit offering a yield of six per cent, an investor lucky enough to have a $100,000 nest egg can generate a monthly income of $500 before tax.

However, term deposit rates tend to follow the Official Cash Rate (OCR) quite closely, which means these attractive rates are on borrowed time.

At 5.50 per cent, the OCR is at its highest level since late 2008. That looks to be the top, and the bigger question is how long we stay here.

That’ll be a function of how the economy develops, and how quickly inflation slows from here.

At 4.7 per cent, the annual inflation rate is still well above the Reserve Bank’s target range of 1-3 per cent.

It doesn’t need to wait until it’s within that range before cutting, mind you.

The Reserve Bank’s remit is to keep future annual inflation between one and three per cent over the medium-term, which typically means between 18 months and three years.

In other words, as long as it has confidence inflation is headed toward two per cent over the next couple of years, it will consider cutting the OCR.

Financial markets are picking the first cut could come as early as May, although most economists believe the Reserve Bank will wait until August before it starts reversing course.

Either way, the upshot is that anyone sitting comfortably in term deposits is facing a declining income stream in the months ahead.

Markets expect the OCR to be almost one per cent lower by this time next year, and some economist forecasts have it at 3.50 per cent six months after that.

That monthly income of $500 looks safe for now, but it could be closer to $400 this time next year and headed for $300 in 18 months.

That could mean a more than 30 per cent fall in income within 18 months.

Short-term deposits are offering great value right now, but don’t get too content. Within six months interest rates could be headed lower, and after the first cut they’re likely to keep falling.

If that happens, investors will be facing much less attractive reinvestment rates and a rapidly declining income stream.

In contrast, one can lock in a yield of five to six per cent from a high-quality fixed income portfolio, with a maturity stretching out years, rather than months.

Investors would be wise to take advantage of this while interest rates are high, and make hay while the sun is still shining.

A changing market dynamic could have important implications for other asset classes too.

The local sharemarket is offering a dividend yield of about 4.3 per cent (including imputation tax credits), which isn’t far off the highest in almost five years.

That’s not quite as enticing as six per cent in the bank, but this dividend income is likely to grow over the next two to three years, rather than fall sharply.

By the second half of this year, money could be moving back toward other assets amidst falling deposit rates.

Rather than waiting for the herd to catch on, savvy investors might want to think about adjusting their strategy sooner rather than later.

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