Talk to an American and they will tell you something Australian investors find hard to understand: equities are for growth and bonds are for income.
In the US, you don't invest in equities for income; you invest in them for growth. To them, the idea that you would invest in equities for income is anathema. In the US, you buy equities for risk and bonds for safety, but you can't have both.
"But what about the banks?" I hear you ask. The Australian banks have spoilt us. In the 1990s, they provided both income and growth and conditioned us to expect both. The legacy is a dangerous expectation.
What a lot of Australians overlook in their pursuit of income is that the risk in an equity share price almost completely negates the yield on almost any stock, and while some shares are painted as "safe income", it's just a marketing line that hides the reality that their share prices move by more than their yields many times a year, including the banks.
Quite honestly, dividends and franking are almost irrelevant when compared with total share-price risk. Dividends are simply a component of a very volatile total return, as anyone caught in the recent rapid bank sector selloff can attest.
But that's OK - you keep telling yourself its "safe". The point about risk has been driven home in our market in the past few weeks. The market has become extremely volatile and, despite the daily noise that says otherwise, it's not an opportunity; for investors, it's a turnoff. Investors want certainty and will batten down the hatches until they get it. How do they do that? Here are some options, and for the equity brokers among us, take heart, because none of them are sexy.
Alternatives to the sharemarket:
A case of beer At least you get some value out of the investment. Better than losing money.
Pay down debt This is perhaps the best investment any of us could make at the moment. When you consider that a 45 per cent taxpayer paying 8 per cent on debt can achieve a 14.5 per cent risk-free return by paying down their mortgage or paying off their car loan, you can see this is a no-brainer.
Other investments No one in equities would ever suggest it, but there is always the property market. Although, if I were investing outside equities, I would prefer investing in my own business. Or, you should invest in the lowest-risk, highest long-term-return assets you can: yourself and your career.
Put the money in an interest-bearing cash management account Most of these accounts are really designed as a short-term transaction facility and pay lower rates of interest than are available elsewhere.
Corporate bonds The corporate bond market in Australia is an institutional market and most of it is traded over the counter (not on an exchange). Some specialists can access the secondary corporate bond market for you but when interest rates are low, there could be little left after they extract their fees.
Government bonds You can buy bonds directly from the Reserve Bank and some state governments and there are now exchange-traded bond exposures available on the Australian Securities Exchange. But yields are low for these low-risk assets and when it comes to "income", with interest rates this low, they are simply a "capitulation" investment. Buy them to avoid losing money, not to make money.
Hybrids Most offer higher yields than bank accounts and bonds in return for you taking on equity exposure. They are not risk-free; typically they are about half as volatile as the underlying equity. Some got smashed in the global financial crisis but, radical events aside, they are "sleep more, earn more". OK if you know what you're doing.
Term deposits This is perhaps the logical place to park money. Nothing complicated, nothing new, nothing greedy. They pay higher returns than cash management accounts and bonds. There are a number of traps and tricks with term deposits; not all are the same, and the advice is to stick with major institutions, not lock in for longer than you think you need to, and be completely aware of "honeymoon" rates, break clauses (nasty) and conditions. And remember that rates are falling, so your return is likely to decline over time. Lock in now and you might find yourself rolling them at lower returns, whereas with bonds you can lock in for a lot longer.
And for those of you thinking rates are coming down and yields are too skinny, don't forget to add the benefits of waking up from a good night's sleep enveloped in financial certainty. Compared with losing money, even 0 per cent can be a good return.
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