Term deposits versus fixed income investments
Thursday, May 30, 2013/
This is part five in SmartCompany’s five part Investing special report: The rules of investment. Written by SmartCompany and brought to you by Bendigo Bank.
Historically, fixed income investments have never been as popular with Australian investors as shares or term deposits, but it seems times are changing.
Market conditions have led more Australians to consider the merits of fixed income investments, rather than the safer option of a term deposit or the riskier one of shares.
Advantages and disadvantages
Term deposits are the safest investment you can make, as long as you select your bank wisely. Generally speaking, placing your money with one of the major banks is the way to go, as they have a smaller chance of collapsing.
Term deposits are a safe investment, with guaranteed returns and control over the length of time of the investment. On the downside, investing in a term deposit account prevents you from accessing this money for the duration of the investment period.
Before investing in a term deposit, ensure you can afford to lock away your savings and keep some money aside in case of an emergency. Banks offer other account options which pay interest, but also allow you to access the money.
The types of fixed income investments are varied, but often they come in the form of bonds.
Effectively, when you invest in bonds you are lending money to a government or a company at an agreed interest rate for a certain amount of time. In return, you are paid interest on your original investment at regular intervals and receive the value of your loan back at the end of the term. Investing in bonds has varying levels of risk and return. If the company carries a high risk (it has greater potential to run into financial difficulties), then the rate of return will be higher.
Investing in government projects tends to carry very little risk and the rate of return is much lower. Some bonds are listed on the ASX and these bonds allow you to sell the investment if need be, giving you greater flexibility than a term deposit.
The Australian Securities and Investments Commission says on its website that fixed income investments can be a “defensive investment” as the market value of bonds can go up and down depending on the economy and interest rates.
CPA Australia business policy adviser Gavan Ord says Australia doesn’t have many corporate bonds, but retirees often favour fixed income investments because of the annuities.
Ord says bonds can “provide a nice income stream” but have simple interest, whereas term deposits usually have compounding interest.
He says term deposits, in this respect, can be more advantageous if they offer a high interest rate, but at the moment interest rates are significantly lower than they were during the global financial crisis.
Current investing trends
Research senior manager at Bendigo Wealth, Julie McKay, says fixed interest investing is “new territory” for a number of investors, since they’ve been a missing asset from Australian investment portfolios for a number of years.
“This type of investment has been missing from the Australian asset class for quite a while, people have always favoured investing in property or shares because this is what people knew, but now more people are investing in fixed interest,” she says.
McKay says as interest rates on term deposit accounts have fallen, people have turned back to shares, but more so fixed interest investment options.
Current interest rates on term deposit accounts are around 4.5%, but McKay says when you factor in inflation this drops to around 2%, which isn’t appealing to investors.
Ord says during the global financial crisis, investors returned to term deposits as they had a low risk appetite and the banks were offering interest rates of 6-7%.
“For banks, some of their funding sources dried up during the global financial crisis and became more expensive. So they went back to a more traditional source of funding, deposits. This caused the banks to offer more competitive interest rates,” he says.
In the long run, Ord says the switch away from term deposits has been occurring over the past 25-30 years and the global financial crisis will be seen as just a “blip” in what has otherwise been a surge of people toward shares, property and fixed income investors. Despite this, he says term deposits will not disappear as an investment type.
“Banks are now looking to be a little more balanced in their funding nicks. They’ll source more through term deposits than before the global financial crisis, but not as much as during,” he says.
McKay says all signs are pointing to fixed income investments becoming more prominent among Australian’s investment portfolios.
“No one is thinking the interest rates are going to go back up to what we were seeing previously. So it’s likely a lot of people will remain who want to get into this asset class.
Banks are issuing bonds to the retail investors themselves, so it’s unlikely they’d be doing this kind of thing if they didn’t think they were here to stay,” she says.
Current options for investors
While typically it’s been difficult for individuals to pursue fixed income investments in Australia because corporate bonds have been in short supply in Australia, and there’s been a shortage of government bonds available to individual investors, there are options.
McKay says investors are able to invest in bonds through managed funds which offer more security than individually investing.
“Traditionally it was difficult for retail investors to invest in these, but managed funds are where most of retail investors would get most of their fixed interest exposure.
“All the big managed funds offer a fixed interest style of investment. They’re effectively investing in corporate bonds,” she says.
McKay says there are further options aside from just fixed income and term deposit investments such as hybrid securities and the Sandhurst Trustees fund (a fund which offers a diverse investment portfolio).
ASIC says hybrid securities are different to ‘standard’ corporate bonds because investors take on ‘equity-like’ risks, but receive ‘bond-like’ returns. These tend to be riskier.
For businesses or individual investors, Ord says it’s important to look at the investment return.
“You should look at the return on the investment, how much return are you actually getting? A baseline for you should be: is your return investment better than a term deposit rate? If it’s not, consider if it’s worthwhile continuing or if you should be in a term deposit,” he says.
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