Investors looking for low-risk income from term deposits should consider shifting their exposure to bonds as the recent rise in interest rates is unlikely to continue, which will reduce their ability to generate sufficient returns, a bond broking firm has noted.
Income Asset Management capital markets executive director Darryl Bruce said the increase in the cash rate from 0.1 per cent in April 2022 to 4.35 per cent by November 2023 had strongly benefited people with cash held in a term deposit, but interest rates were at a downward turning point.
“Despite the fact that Reserve Bank rate cuts are likely to be a few months away, we have already started to see many banks cutting their term deposit rates,” Bruce said.
“The best rates from the big four [banks] now stand at around 4.75 per cent and that is only for periods of less than one year.
“Having said that, there are still a few opportunities from smaller authorised deposit-taking institutions offering returns of around 5 per cent.
“So why not simply fill the defensive part of your investment portfolio with term deposits yielding up to 5 per cent?
“You may be able to secure a six to 12-month term deposit with a rate close to 5 per cent now, but what will the return be when you look to roll the deposit?”
He added high-quality bonds were likely to provide more stable returns over a longer time frame, which could be locked in now to offset the easing interest rate cycle.
“If you’re looking for predictability of income, there are fixed-rate bonds offering returns of 5 to 6 per cent over the next five to 10 years,” he said.
“Alternatively, the income on floating-rate bonds is calculated as a margin over the bank bill swap rate, which moves broadly in line with the cash rate over time, so you can also expect your income to move up and down with the cash rate.
“With the cash rate expected to fall, now might not seem to be an opportune time to invest in floating-rate bonds.”
He pointed out bonds retained a higher degree of flexibility for investors compared to term deposits as they were actively traded.
“Prior to the global financial crisis, it was not too hard, or too expensive, to break term deposits, however, regulators saw this as a vulnerability in banks,” he said.
“Now it is much harder and more expensive to break term deposits. This provides certainty of funding for banks, but it leaves little flexibility.
“In comparison, bonds have an actively traded secondary market. The liquidity in large investment-grade bond issues is relatively good, which is a significant advantage.”
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