Conservative Portfolio: Investing in fixed interest

There are trade-offs to be made when deciding between term deposits, bonds and bond funds, as Richard Livingston explains.

Key Points

  • Government bonds (including those now listed on the ASX) aren’t attractive
  • RaboDirect have increased their five-year term deposit rate to 5%
  • In our circumstances we favour the term deposit

Our Conservative Portfolio has a small portion of its Australian fixed-interest allocation yet to be invested. We’ll use this investment as an opportunity to explore the key issues when choosing between term deposits, fixed-interest funds or the new ASX-listed government bonds.

capitulation – and can provide liquidity so you can take advantage of any opportunities that arise.

Term deposits, fixed-interest funds and government bonds can all play the balancing role, but term deposits don’t provide the same liquidity. Bonds and funds can be redeemed quickly, but term deposits are either locked-in, or carry a hefty penalty for accessing your funds early. Let’s consider our options.

Government bonds

Government bonds are available to retail investors in several ways. Firstly, there’s bond exchange traded funds (ETFs) which, as we explained in illiquid, we might feel differently. But with the portfolio we’ve got, we’re comfortable sacrificing the liquidity and putting the extra 1.8% in our pocket each year.

Actively managed funds?

With a liquid portfolio, term deposits are an easy winner over government bonds. But what about actively managed funds, like the Schroder Fixed Income Fund we already hold?

It’s a much tougher call. The Schroder fund, for instance, isn’t limited to government debt, so it can generate extra returns through taking on more credit risk (not just lending to lowly rated sovereigns) and shifting the duration of its portfolio. We’d expect the Schroder fund to outperform government bonds in most scenarios, but whether they can beat the 5% per annum on the RaboDirect term deposit over five years isn't at all clear.

The current yield to maturity of the Schroder fund portfolio is about 4% per annum. It’s tough to see them adding 1% per annum of added value (after costs) and, even if interest rates were to fall to zero, we're unlikely to liquidate our entire cash and fixed-interest portfolios. Whilst the unit price of the Schroder fund is likely to rise if interest rates fall, this is only of benefit if we sell. So we’ll take the 5% on offer from RaboDirect and leave our Schroder investment as it stands.

We might feel differently if interest rates were higher, since we’d be more comfortable investing in funds holding longer-term securities (a weakness of term deposits is that the longest maturity is typically five years, leaving you with reinvestment risk). It might also be a different story if the bulk of our existing investments were term deposits, or RaboDirect was paying us a lower rate.

It’s worth paying a bit for liquidity, but only if it has value to you. Whilst this is another situation where there’s no right or wrong answer, with 15% in a bank account and 20% already in liquid fixed-interest funds, we’re comfortable we don’t need any more.

Model portfolio changes

We’ll shift $20,000 from our online savings account to the RaboDirect five-year term deposit, bringing the Australian fixed-interest allocation of our Conservative Portfolio to its full 25% weighting.

In our upcoming quarterly report, we’ll review our current bank account arrangements and see how our portfolios are faring overall.

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