Question: I have very little money sense, could you please explain the difference between the cash rate and the real cash rate. Is this when you have an interest only loan and inflation is helping you to pay it off at the end?
Answer (by Peter Switzer): Thanks for the question about the ‘real’ cash rate. This is where we have adjusted the nominal cash rate for the effects of inflation.
It is best thought of from the perspective of an investor. If the RBA cash rate is 2.5%, and inflation is running at 3.0%, then effectively you go backwards over the course of the year. After 12 months, your $100 is now worth $102.50 with interest, however goods that cost $100, 12 months ago now cost, with inflation, $103.00. You have gone backwards by 50 cents. The ‘real’ cash rate, in this example, is -0.50%.
So, the ‘real’ cash rate = the RBA cash rate – inflation.
And it also works the other ‘way round’ as you suggest – as a borrower with an interest only loan, inflation is helping you pay it off.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Charlie Aitken: CBA – all class
- Roger Montgomery: Why I don’t like mining services
- Andrea Slattery: My SMSF
- Penny pryor: Buy, Sell, Hold – what the brokers say
- Gavin Madson: High-yield bond market opens up
- Tony Negline: Deferred lifetime annuities – expensive waste of time?
