How can savers deal with declining deposit rates?

Lower interest rates have been a cause for celebration for many people in recent months.

Borrowers and homeowners have seen their costs fall sharply, and there’s more support to come.

However, conservative savers with money on term deposit won’t be quite so enthusiastic about slumping interest rates.

They were sitting pretty 18 months ago, with the six-month term deposit rate offering a yield of six per cent, the highest since 2008.

That was as good as it got, and since then term deposit rates have consistently declined.

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Right now my bank is offering 3.45 per cent, which is a 43 per cent decline.

That’s a hefty pay cut, if your term deposit nest egg is a key source of income.

Many of today’s struggling households would find it difficult to sympathise with those who are debt free with excess savings to invest.

If you’re lucky enough to be in that position, you’re quite likely a homeowner too so the interest rate you’re getting on your capital is definitely a first world problem.

But a lot of people are in that boat right now, with some $161bn sitting in bank term deposits on behalf of New Zealanders.

That’s up by more than 70 per cent since 2021, when the six-month deposit rate collapsed to a historic low of 0.8 per cent.

One consolation for despondent depositors is that they weren’t earning as much as they thought anyway.

Six per cent was an attractive headline, but after 30 per cent tax that falls to 4.2 per cent.

Inflation was running at about four per cent annually over that period, so after that too there’s not much left.

Sadly, things will probably get worse before they get better.

Markets see another 0.25 per cent cut to the Official Cash Rate (OCR) later this month, and potentially one more after that, depending on how the economy develops in early 2026.

Against that backdrop, term deposit rates are almost certain to go lower from here, and they could fall below three per cent.

Remember you’ve got that pesky tax and inflation to subtract as well.

Negative returns, anyone?

If you’re staring down the barrel of a halving in your term deposit income, your options are limited.

You can adjust your lifestyle and reduce your spending to match that lower income, you can start dipping into your capital, or you can try and get that money working a bit harder for you.

Each to their own, but for many savers option number three might sound like the best one.

While six per cent was a reasonable hurdle, it’s not too difficult to beat three.

However, many of the alternatives out there will involve moving up the risk curve and introducing more volatility into your investment mix.

Fixed income (or bonds) is the natural option, as this would make for a modest income boost while keeping the risk profile relatively conservative.

Property and shares are the next cabs off the rank, with the returns from these asset classes typically well above what one would receive in a term deposit.

The current residential rental yield is 3.8 per cent and New Zealand house prices have typically grown 5-6 per cent annually over the last 30 years.

The costs of property ownership can be high so one needs to account for rates, insurance, maintenance and the like, as well as the hassle factor, which can be high.

New Zealand shares have returned 8.5 per cent annually over the past 30 years, while higher-growth US shares have delivered 10.5 per cent per annum.

Those numbers include dividends paid, which can vary depending on the market.

New Zealand shares are a good income generator, better than property in fact, and the dividend yield is about four per cent (including imputation credits).

Sectors like utilities, infrastructure and real estate offer higher yields of six per cent or more.

For international shares you should only expect 1-2 per cent, with the vast bulk of your return likely to come from capital gains.

A share portfolio doesn’t manage itself either, but the running costs are much lower than a rental property and it’s obviously more hands-off.

However, before you move all that term deposit money into a US share fund consider the much higher level of volatility you’re likely to face.

Historically, US shares have experienced a 10 per cent fall every two years (on average) and a larger 20 per cent plus decline about every 6.5 years.

Your long-term returns will be excellent, but you must be prepared to lock your money up for at least 10 years and to stay calm during those inevitable rough patches.

It’s a similar story for property, albeit the volatility is likely to be lower to match the more modest returns.

The last few years are a good example.

New Zealand house prices fell 18 per cent from 2021 to 2023, and they’re still 3.5 per cent down from three years ago.

The income drop term deposit investors are facing can certainly be filled, but it will come with a few trade-offs.

A combination of fixed income, diversified PIE funds, real estate, and income-generating shares will almost certainly deliver better bang for your buck over the coming period.

The exact combination depends on the individual, and it’s probably time you spoke with your investment adviser.

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