This week we are going to look at the risk and return characteristics of fixed interest investments and how these could fit into your overall investment strategy. When you make an investment in a fixed interest product you are essentially agreeing to lend an institution (say a bank in the case of a term deposit), or a government (in the case of a government bond) or a company, money. In return they agree to give you regular interest payments and at the end of the period they will give you your initial investment (capital) back.
Common examples of fixed interest investments include:
- government and semi government bonds,
- corporate bonds,
- term deposits,
- secured and unsecured notes
- hybrid investments.
Generally speaking, fixed interest investments are considered to be more risky than holding your money in cash but overall are considered quite low on the risk spectrum. But it should be noted, just because an investment is in the fixed interest area this does not necessarily mean that it is low risk and that you will get all the capital you invested back or that you are guaranteed to receive interest payments. As always, you need to understand the true nature of the investment and the risks associated with the investment.
So here are some things to look out for when making a fixed interest investment:
(1) How often are the interest payments made? Some investments pay monthly, some quarterly and some annually. Make sure the timing of interest payments meets your investment needs.
(2) Are the interest payments fixed or variable? Just because the sector is called fixed interest, it is not necessarily true that your interest payments are fixed, it depends on the type of investment. Some investments in this sector make variable interest payments. This means that the amount of interest you receive rises and falls with movements in the level of official interest rates set by the Reserve Bank of Australia. So if you had made one of these investments a couple of years ago, your interest received would have reduced in line with official interest rates falling. If the interest rate is fixed, then you will receive the same amount of interest over the life of the investment, regardless of what happens to official interest rates.
(3) Is the investment for a fixed term or at call? At call investments mean that you can access your money at any time (although some products may require a day or two’s notice). If your investment is for a fixed term, it means you are invested for a specific length of time.
(4) Ultimately who are you lending your money to? Knowing this will help you judge how likely it is that you will get all your interest payments and your capital back. So in the case of a term deposit, as you are lending your money to a bank. This is considered one of the lowest risk forms of fixed interest investment. In the case of a government bond, you are lending your money to the Government. Nowadays, this is more tricky to judge how safe your money is, as it depends on which government :-). If you are lending your money to a company, the amount of risk you are taking is very dependent on the type of company, their own individual financial situation and the industry they are in. It is very important to understand who you are lending your money to as this very much determines the overall level of risk you are taking in your investment.
(5) Watch out for the term “secured” in the name of your investment, it doesn’t necessarily mean that your money is safe it simply means that the issuer has provided some form of security to the trustee of the note issue.
So if you want a relatively safe investment, giving you regular interest payments, the fixed interest sector might be for you. But like with all investments you need to understand all the terms and conditions to make sure that the investment meets all of your needs. As despite the name, fixed interest investments can be very different in terms of risk and return.
Next week we will look at the characteristics of investing in an old Aussie favourite – property!
If you liked this post check out the rest of the series by clicking on the links below:
* Please note this is for your general information only and does not constitute financial advice