What is a fixed income source?
A fixed income source is generally an investment that secures your money and provides fixed payments over a certain period of time. Examples include bank deposits and government bonds.
Interest rate facts:
1. The cost of borrowing money is determined by interest rates. The higher the rate the more you pay.
2. Interest rates determine what you get paid for your fixed investments. The higher the rate, the more you earn as an investor.
3. Interest rates are dependent on many factors including local and international economic conditions.
4. The Reserve Bank is the chief cherry in charge. Their main purpose in life is to control inflation, and they do this by adjusting the primary rate (also known as prime or Federal Funds Rate).
5. The prime rate determines the price at which local banks lend money to consumers or pay investors.
6. The primary source of income for pensioners is bank deposits.
7. The state has direct control over pensioners’ lifestyles as the reserve bank controls interest rates.
What are the implications?
Have a look at the following scenarios:
A. Home owner
20 year home loan: $100,000
Interest rate: 10% = Monthly bond repayment of $965
Interest rate: 5%; = Monthly bond repayment of $660
B. Investor
Bank deposit: $100,000
Interest rate: 10% = Monthly interest income of $833
Interest rate: 5% = Monthly interest income of $417
In a high interest rate environment home owners pay more and investors earn more. In a low interest rate environment home owners pay less and investors earn less.
What you generally find with retirement planning is that the older you get the more conservative your investments become. In other words, the proportion of fixed investments increases to provide a steadier and more secure source of income.
This is where the problem comes in. Income from fixed investments becomes highly susceptible to interest rate changes. This presents a challenging situation for pensioners because lower rates result in lower monthly interest income.
I’m sure the problem is obvious to you by now:
1. The greater your reliance on fixed income investments, the more control you relinquish to the state.
2. It is very difficult to predict how inflation and prime rates will change over time. As a result, pensioners face an uncertain and difficult future.
Three key lessons:
1. Effective wealth creation is based on control over risk and return.
2. Distance yourself from income sources which are dependent on interest rates.
3. Invest your time and energy in passive income streams which enable control by you. Property and online business are two powerful examples.