Author Katrina Shanks, CEO Financial Advice NZ Article originally published on Stuff.co.nz.
With inflation recently confirmed as running at a 31-year-high, where we put our investments becomes ever more important.
As I have written here previously, one of the keys to investing is staying ahead of the rate of inflation, because inflation erodes gains made from anything you invest or save.
That’s why investment decisions should be made with inflation in mind, and that’s especially so with inflation running at 6.9%.
I’ve discussed shares and property in depth, and how over a longer period of time (allowing for peaks and troughs) they will do a great job in helping your money stay ahead of the rate of inflation. And how cash won’t likely be enough alone to meet any long-term goals, but could be a safer part of a bigger investment plan or portfolio that includes shares, property, and also things like fixed-interest bonds.
So, what about fixed-interest investments such as bonds?
They often fly under most people’s radars because they don’t receive a lot of media attention in the same way shares or property do, and in the past haven’t been as easy to access or set up as a cash savings account.
But they are similar to cash in many ways, in that they have lower risk. But like cash, they have a lower return.
Bonds are the best-known fixed interest investment. They are where you lend money to the government, a council, or a company, who usually use your money to build infrastructure such as roads, or water assets.
In return, they promise to pay you a set interest rate, and when the bond matures, say between six months and 10 years, you get your investment plus interest.
The big bonus with them is they can offer you good liquidity, meaning you can have quick access to your money should you need it.
Unlike term deposits, you can sell them before they reach their maturity date. However, if you do that your return may not be exactly the same as the rate when you took them out. It really depends on what interest rates are in the market, if rates are lower, the price might be higher, but if it’s like what has happened in the last 12 months (in particular) the interest rate of the bond is less than a new one, so is not valued as highly if you sell it.
But the big thing is they are generally low risk, with those offered by the government or councils being the most secure, with those offered by companies a little higher risk.
You can buy individual bonds, part of an exchange-traded fund or as a fixed interest managed fund.
When buying individual bonds, it pays to remember no government or council bond issue in New Zealand has ever failed to pay out what they promise, though when it comes to companies there is not the same certainty. Because of that risk, company bonds tend to pay a higher interest rate.
The price you pay for them depends on investor demand at the time.
It also pays to remember bond prices fall when market interest rates are high or rising (as they are now), and the reverse also applies
As I said earlier, bonds haven’t had much publicity or been easy to access, but this has changed in recent times, and they are now available not just through share brokers, but also via online share apps such as Sharesies and Hatch.
Or you can buy directly from the entity issuing them.
One example is the Government’s Kiwi Bonds. These are issued in six-month, one-year, two-year and four-year maturities. The minimum amount that can be invested is $1000 with a maximum of $500,000 in any one issue.
You can also buy bonds via an exchange traded fund (EFT).
This is where providers of managed funds put money from many investors into one fund and buy a number of different bonds, so spreading the risk.
This can be a low-cost and low-risk way of getting into bonds, because a basket of bonds will give you exposure to a wide range of companies and industries, which covers you should one industry experience a downturn in demand for some reason.
Bonds can be a long-term or a short-term investment, depending on how soon you want your money to be available, but the shorter the term then the lower the interest rate you will get on your investment.
As with other investments, it pays to seek advice, and in the case of bonds this will be around the different levels of risk and the fees – administration or performance fees – that might accrue if you are in an ETF.
Bonds, as they are for shares, property and cash, can play an integral part of a diversified and balanced investment portfolio, with your level of risk and how soon you need your money determining what proportion of each you take up.
In short, bonds are seen as quite a cool way of investing, particularly if you are worried about your exposure to high risk but are looking for something to give you a bigger return than just a cash account in the bank. Like cash, they tend to be favoured by those who don’t need their cash in a hurry but need to know it’s safe. Bonds can be negative though if not held for the term, and with high inflation, the ‘real’ return may be negative. But you should be comfortable that you will get your capital back at the end of the investment term (for an individual bond).
Personally, I have never bought bonds directly – but after some further consideration this may be an option in the future. However, I do have managed funds which I know have bonds in the portfolio.
As my financial adviser would say, determine what your risk is and always invest with inflation in mind, doing your best to find something that earns you more than that if you can.