Where to invest when term deposit rates are low
For many investors it's a constant challenge to find the balance of income, growth and security that's right for their investment objectives and risk appetite.
The need for yield isn't changing but ways to find it are.
Here are the top five reasons to look at corporate bonds, especially when term deposits rates are falling.
1. You want to remain defensive but optimise your income
Many people use term deposits as the primary defensive allocation in their portfolio because they are low-risk investments that typically offer a better rate of interest than a traditional bank account.
However, term deposit rates are currently very low and may go lower, with returns being impacted by inflation.
At the same time, corporate bond yields are higher, because the yield curve has steepened. The current spread between term deposit rates and bond yields means that bonds offer significantly higher income than term deposits, without a significant increase in risk.
2. You want to preserve capital but you also want flexibility
You don't want to put your capital at risk, so investments such as shares and hybrids may be unattractive. Their higher risks may be acceptable for growth assets but not for the defensive part of your portfolio.
Term deposits have no volatility, so the question to consider is: does moving to higher-yielding and more flexible corporate bonds stack up in return for a small increase in volatility?
With term deposits, you are lending money to a bank and it is locked in for the entire term. With corporate bonds, you lend money to a successful ASX 100 company and have the ability to access your capital at any time.
3. You get the face value back
When corporate bonds mature you get the face value back, in addition to the regular coupon income that you have received during the life of the bond. This may sound obvious but it's fundamental. Volatility only matters if you sell early.
4. You want predictable income
Many people think of bond funds or exchange traded funds (ETFs) as comparable to holding bonds individually - but they are not.
Bonds mature while bond funds and ETFs are perpetual, just like shares.
With bond funds and ETFs, you have to sell funds to realise your investment - there is no capital repayment and income payments are unknown. Without the return of known capital, you are missing a fundamental feature of fixed income and the predictability that goes with it.
A fund manager cannot tell you what your future income will be - they can't know which bonds will be in the fund or ETF in the future because maturing bonds will be replaced over time.
This lack of capital return and income predictability is the opposite of fixed income, which is all about capital return and predictable income. With corporate bonds you know on the day you invest what the outcome will be: you will receive back the face value of $100 plus known income over its life.
5. XTBs give everyone access to the benefits of bonds
Corporate bonds trade between banks and asset managers in $500,000 minimums. The introduction of exchange traded bond units (XTBs) has made the benefits of corporate bonds accessible. They come in $100 securities so all investors can now access the benefits and returns of individual bonds from ASX 100 companies. Investors can buy or sell XTBs, which are traded on the ASX, at any time during their lifetime. XTBs therefore provide much more flexibility than term deposits where your money is locked in for the term of the investment.
Investors can select between fixed and floating-rate coupon XTBs from over 25 of Australia's largest companies, meaning that there is an XTB to suit a wide range of investment objectives.
More information on how corporate bonds compare with term deposits including our e-book, The Investor's Guide to Adding Income and Security to Your Portfolio, can be found here.