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Fixed Interest Investment

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:

Investing: How Do I Get Started?

What Is My Risk Tolerance?

Risk and Return

What Are My Investment Choices?

Fixed Interest Investments

Investing In Property

Happy investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice

23/05/2013 0 comment
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So now you have an idea of your risk profile (tolerance) and you understand the relationship between risk and return, it’s time to look at characteristics of the broad asset classes or types of investment.  It is important to understand the different investment types as each category has different levels of expected risk and return.  Understanding what to expect from the different asset types will help you decide which categories of investments best suit your investment goals and your timeframe.

Generally speaking, there are considered five broad investment types or asset classes:

  1. Cash – investments like savings accounts, high interest accounts, bank bills
  2. Fixed Interest – includes government bonds and bond like securities issued by companies called hybrids
  3. Property – includes residential, retail, industrial and office properties.
  4. Australian Shares – are shares listed on the Australian Stock Exchange which cover many different sectors such as mining, healthcare, banking and retail.
  5. International Shares – are shares listed on exchanges outside of Australia including places like the United States, Europe or Asia.

I have listed the asset classes in order of risk.  Generally speaking, cash is considered the least risky investment type and international shares are considered the most risky.

Given the Reserve Bank of Australia (RBA) cut rates again this week it is appropriate we kick off our look at the different investment types with a look at what is considered the safest but lowest return option, cash.

Cash generally refers to investments in high interest bank accounts, term deposits, bank bills and other securities which have a relatively short investment time frame.  An investment in cash provides a stable, predictable income, in the form of regular interest payments.  This category is all about income, with very little risk.

You might have heard the saying “cash is king”?  This saying is usually used when the share market is very volatile.  During these periods, such as the global financial crisis (GFC), investors move into cash for its safety and security.  The problem with cash right now is that interest rates in Australia are at their lowest level since 1960, this means the returns on cash are at very low levels.  However, if safety and security are your top priority or your investment time frame is short, then you can’t go past cash as an investment option.

Inflation is the other issue you need to be wary of when investing in cash, especially when interest rates are low.  Anyone who goes shopping knows that, generally speaking, the price of things goes up every year.  This is called inflation.  It means that a dollar today will buy less goods and services in one years’ time as prices have increased.  At the moment inflation is around 2.5%.  So if you invest in an online account with an interest rate of 3.5%, then your post inflation return is only 1% (the difference between the interest rate earned and the inflation rate).  If inflation is high and interest rates low, then it is possible to make a negative return after accounting for inflation.  For example if inflation is 5%, but the interest rate earned on your account is only 2%, then you will earn a negative return of 3% after accounting for inflation.  This is because the increase in the general level of prices, inflation, is greater than the increase in value of your investment through the interest earned.  This is why it pays to shop around for the best cash rate possible and look out for any bonus interest deals.  One of the best ways to do this is to use a comparison site.  Two of my favourites are:

Canstar

Mozo

They both can give you comparisons on rates for online savings accounts and term deposits, including any bonus rates.  Don’t be afraid to take the best bonus rate then move your money after the bonus period has finished.  But remember, like with all investments read the full terms first before making any investment.

Next week we will look at the characteristics of fixed interest investments.

If you liked this post check out the rest of the series by clicking on the links below:

Investing: How Do I Get Started?

What Is My Risk Tolerance?

Risk and Return

Fixed Interest Investments

Property Investments

Happy investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice.

09/05/2013 2 comments
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