By Gillian Bullock
Fixed-interest investments should be safe and secure but sometimes, if the interest rate is too high, they can be riddled with danger.
Term deposits, cash management trusts, debentures, unsecured notes, bonds and bank bills all make up the world of fixed-interest investments. Basically you invest your capital, then you are paid interest regularly either at a fixed rate or using a fixed formula and at the end of the term your money is repaid in full. Investment terms can run up to 10 years.
Banks, building societies, credit unions, super funds or life insurance companies are all specially regulated by the Australian Prudential Regulatory Authority (APRA) to ensure they can meet their financial promise on fixed interest products under all reasonable circumstances.
- Debentures are usually issued by a finance company and secured by some or all of the assets of the company. Unsecured notes are higher risk than debentures as they are not specifically secured.
- Bonds can be offered by various institutions including the Commonwealth Government and State Governments or by companies listed on the ASX. Bonds tend to be guaranteed.
- Bank bills are short-term offerings with terms from seven to 180 days. They may or may not be secured.
Such investments are traditionally viewed as conservative, as your initial capital is generally returned to you in full at maturity date. The downside is that there is no capital growth so all you will have enjoyed is the interest payment.
In addition the money you earn on fixed interest investments is fully taxed at your marginal rate.
Contrast this with shares where you may enjoy capital growth and your dividends, if fully franked, offer you tax advantages.
Another downside is that you generally cannot access the money until the maturity date. If the institution allows early repayment, there may be a penalty.
Fixed interest investments do have a purpose, particularly if you are looking to place money somewhere short-term, such as the period between selling your house and buying a new one. If you are only investing the money for a matter of months,then fixed interest is probably better than shares as you will generally not be subject to any volatility.
But while many see fixed interest as a conservative investment, it still carries an element of risk, particularly if you invest in the offerings widely advertised in the press, radio and television.
Just recently the Australian Securities and Investment Commission issued a warning against fixed interest investments offering highly attractive rates.
"If you see an investment that offers an attractive interest rate, don't invest a cent until you've checked it against our three-way test," says Greg Tanzer, ASIC's executive director, consumer protection.
- Who are you giving the money to? Only banks, building societies, credit unions, super funds and life insurance companies are regulated by the APRA. Fixed interest investments offered by other bodies involve an extra risk and the company may fail or default.
- Is the interest rate higher than 8.5 percent? If the return offered is high, it may be more risky than a typical fixed-interest investment. Rather than have your capital guaranteed, you may well end up losing some of the money you have invested. Make sure you can handle those risks.
- Do you plan to put all your eggs in one basket? It's unwise to put your entire nest egg into the one investment as you could wipe out your life savings if something goes wrong.
For most people, following the maxim that the higher the return, the higher the risk will ensure you don't run into trouble with fixed-term investments. If the investment offers you returns higher than you would pay for a home loan, then the chances are it may come unstuck.
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