Paul's Insights: Not all fixed income investments are low risk
Term deposits are a favourite investment of many Australians – especially retirees who often rely on the predictable income. The problem is that interest rates have plunged to historic lows.
Six years ago, a 3-year term deposit worth $100,000 would have generated around $4,000 in annual income. Today, that same deposit is more likely to earn just $950 in annual interest. Even worse, inflation is currently running at 2.2%. So the purchasing power of cash held in a term deposit isn’t keeping pace with rising prices.
In a low rate world, it’s definitely worth shopping around. Some smaller financial institutions are offering higher term deposit rates than the big banks. And your money is just as secure. The Federal Government deposit guarantee has made term deposits virtually risk-free – up to $250,000, per depositor, per bank.
Even so, it’s easy to see why many investors would be looking for higher returns, preferably with the same low risk as term deposits. It seems some product providers are capitalising on this.
Investment regulator ASIC is warning consumers about fixed-income investments that are being advertised as term deposit ‘alternatives’ or ‘substitutes’. Not surprisingly, these products have attracted plenty of interest, and consumers have invested significant sums.
ASIC hasn’t named names, but it points out that these investments are likely to be riskier than term deposits. They may be issued by companies that don’t have the backing of the Government’s deposit guarantee, nor are they supervised by banking watchdog APRA. The investments can also be underpinned by higher risk unlisted and illiquid (hard to sell) assets.
You could end up investing in fixed-term funds and debentures. These may sound like a near-equivalent to term deposits but they are very different especially when it comes to the degree of risk involved.
One of the golden rules of investing is that higher returns inevitably mean more risk. ASIC warns that it is seeing products offering only marginally higher returns with much higher risk profiles.
Before you invest, do your homework. Read the product disclosure document and know where you’re putting your money. Higher risk investments are not for everyone, especially smaller investors, who may not have a diversified portfolio.
If you want to play it safe and stick with term deposits, don’t feel you have to accept a financial institution’s advertised rates. If you have a reasonable sum to invest, you may be able to negotiate a higher return. It never hurts to ask.
For more on income strategies in retirement see An Investment Strategy for Retirees by Evan Lucas.
Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.