Current strategies on how investors can maximise their defensive returns through fixed income.
- A period of stable, low interest rates will be great for borrowers but not for investors.
- Strategies include: keeping term deposits short dated, moving funds between at call accounts to utilise honeymoon rates and investing in bonds for higher returns.
Interest rates look set to remain at low levels for longer.
This month, the Reserve Bank kept the cash rate on hold at 2.50 per cent for the seventh consecutive quarter and Glenn Stevens, the Governor commented “On present indications, the most prudent course is likely to be a period of stability in interest rates”.
Income from deposits continues to grind lower than the modest rates achieved last year, as higher paying fixed rate investments mature. Coupled with recent cuts to bonus saver and online accounts, investors with high allocations to deposits are forecast to have another year of low returns.
Low interest rates imply low growth and low returns across asset classes compared to historic returns. While recent returns in shares and property have been attractive, it is important to remember that higher risk assets are also more volatile, so a change in market sentiment can mean gains are eroded quickly.
Theoretically, investing in higher risk assets like shares and property should improve returns but investors have no way of knowing what those returns will be until they decide to sell the assets.
Bonds, like deposits, provide certainty that investors’ need, where projected returns are known from the date of investment, assuming investors hold the bonds to maturity.
Low risk, corporate bonds for retail investors, offer yields to maturity of up to 6 per cent per annum and remain a good alternative for those looking to increase their term deposit returns. Bonds are tradeable investments so investors do not have to hold until maturity and can sell if they need to access funds.
Current strategies that investors are using to maximise defensive returns include:
- Keeping term deposits short dated. While longer dated term deposits are offering higher returns, the increases are marginal and not considered worthwhile in exchange for locking away funds for three to five years.
- Opening new at call accounts with honeymoon rates and moving funds to maximise returns.
- Investing in bonds for higher returns for minimal increases in risk over deposits.
- Investing in higher risk bonds to boost overall portfolio returns. Bonds have a range of risk and return attributes and there are higher yield bonds available that pay a yield to maturity of up to 9 per cent per annum.
- If you think interest rates have hit the low point in the interest rate cycle, then start adding floating rate bonds. Income on these bonds will move up and down as they are linked to a benchmark. Bendigo and Adelaide Bank brought a subordinated floating rate bond to the market this year that is available to retail investors which has a projected yield to maturity of 6 per cent. If the market expects interest rates to rise, the income on these bonds will also rise. Investors can reduce administration of rolling over short term deposits and shopping for the best rates by investing in floating rate bonds.
- There are still fixed rate bonds paying very attractive high yields. Buying these bonds adds certainty to portfolios as income is fixed for the life of the bond.
- Add inflation linked bonds. The margins these bonds pay over inflation is approaching term deposit rates. Should inflation spike, income will follow, protecting capital value.
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