Just because an ad for an investment is stamped with the word “guaranteed” doesn’t necessarily mean your money is safe or you’ll end up getting the promised return.
A guarantee is only as good as the guarantor and, at the moment, even some nations are having difficulty paying their debts.
That’s not stopping investment providers from making big promises about the returns on offer and the safety of your capital.
From bank deposits, through to bonds, debentures and structured products, financial product providers are cashing in on investor fear and your growing desire for capital security and profit certainty.
How do you know which investments to select that will deliver on their promises of capital security and predictable returns? YMM assesses a range of investments to help you decide which will give your money the smoothest ride.
1. Keep it in the bank
Bank products such as term deposits, online savings accounts and cash management accounts let you earn interest on a deposited sum of money. Greg McAweeney, executive general manager of RaboDirect, says bank deposit products are low-risk, easy to access and understand, highly liquid and now come with an ongoing Commonwealth Government guarantee.
“Deposits are risk-free up to the current $1m deposit protection limit under the financial claims scheme (Federal Government), until February 1, 2012, when the limit will be reduced to $250,000,” he says. “This provides a lot of reassurance to customers, particularly those nearing retirement.”
How they work:
You deposit a sum of money with a bank, for an agreed period of time, in return for fixed interest payments. At the end of the term, you are repaid the initial deposit and the accumulated interest. A term deposit will suit you if you can go without a sum of money for a certain period of time: the longer the term, the higher the interest rate.
Minimum investment: $1,000-$10,000
Maximum return: 6.1%-6.4%
Costs: fee-free unless you break the agreement and need your money, which can result in costs, determined after the institution calculates lost interest, plus administrative fees.
Timeframe: one month to five years
Advantages: known rate of return; guaranteed by the Commonwealth Government; simple in nature and easy to open
Disadvantages: you’re locked into the agreement and can’t access your money without forfeiting interest; rates are relatively low and inflation will erode returns over time
RaboDirect - Term Deposit:
- minimum deposit: $1,000
- maximum deposit: $1,000,000
- investment terms: one month, three months, six months, one, two, three, four and five years
- rates: lowest 5% (1 month); highest 6.10% (5 years)
- fees: $0
- contact: 1800 445 445, www.rabodirect.com.au
Cash management accounts
How they work: you deposit a lump sum, earn a moderate rate of interest and retain access to your money; like a cross between a savings and transaction account. The more money you deposit, the higher the tier of interest you’ll be paid. This will suit you if you have a decent sum of money that you may need access to, but also want to use to earn interest.
Minimum investment: $1,000-$25,000
Maximum return: 5.5%
Costs: $0-$35 monthly. Higher monthly fee = more free transactions
Timeframe: no lock-in period. Investors can access money as soon as necessary.
Advantages: highly liquid; day-to-day access to money; known returns; guaranteed by the government; better rates for more money deposited
Disadvantages: rates lower than term deposits and savings accounts; Inflation erodes returns over time
AMP -eASY Cash Management
- access to money through card/ATM, internet, phone, linked accounts
- no minimum or maximum investment
- no lock-in period
- daily withdrawal limit: $1,000
- interest: 4.75% (calculated daily)
- fees: $5 per month
- contact: 1300 157 820
Online savings accounts
How they work: you deposit money into an online account, where it earns interest provided you do not breach transaction limits. Some accounts have tiered interest rates, encouraging you to save more. Make sure you only transfer what you can afford to the account. If you’re stuck and have to withdraw money, you can lose your interest completely for the month.
Minimum investment: $0-$10
Maximum return: 6%-6.51%
Costs: $0-$10 monthly fees
Timeframe: No lock-in period. Some bonus rates revert to smaller rates after a few months.
Advantages: highly liquid; guaranteed by the government; known returns; easy to access and monitor
Disadvantages: limited flexibility, an emergency withdrawal may lead to removal of interest earned for the month; some institutions require linked accounts to be opened
UBank – Usaver
- bonus interest rate: 6.51%
- base interest rate: 6.01%
- no linked account required
- access via internet and phone
- fees: $0
- contact: 13 30 80, www.ubank.com.au
Hot Tip: Government guarantees
The Australian government currently guarantees deposits made in regulated banking institutions up to a cap of $1 million under the Financial Claims Scheme. The cap will be reduced to $250,000 in February 2012, after being set at the higher mark in 2008 to provide certainty during the economic meltdown, when the US and European banking systems were in crisis. The scheme has never been used, which indicates strong Australian banking regulation. The decision to continue the scheme beyond next February is the first time Australian investors have ever had an ongoing government guarantee on bank deposits.
2. Structured products
How they work: investment banks and some fund managers issue what’s become known as ‘structured products’, offering you the chance to guarantee 100% or a lower percentage of your capital but still get some exposure to growth assets like shares. There are many variations available and these products are not easy to understand. Some involve ‘leverage’ so just because there’s a capital protection component doesn’t mean they’re risk free. The higher the level of capital protection you request, the lower your exposure to the growth assets and so the lower your potential returns.
The capital security is usually achieved by the product issuer using part of your initial investment to purchase a zero coupon bond or putting some of your capital into a cash account (or both). The remainder is then invested in a “basket” of assets designed to reflect the performance of a particular index or market segment. The capital guarantee only applies if you redeem the investment on the exact maturity date so you can actually lose money if you need to get out early. If the market-linked segment of the product perform badly some providers switch the whole amount to a cash investment option but your money is still locked in until maturity so there can also be an opportunity cost.
Minimum investment: $3,000-$5,000
Maximum return: up to 50%, depending on the performance of underlying asset.
Costs: no ongoing fees; costs are usually embedded (hidden) in the initial investor outlay. If you use a financial adviser, additional fees may apply.
Timeframe: three to five years on average
Advantages: greater potential returns than bank products; offers the ability to protect your capital but still get exposure to growth assets
Disadvantages: greater potential losses; capital protection is surrendered if you redeem your investment before maturity. The product fine print may include sentences like this one taken from Macquarie Bank’s Tailored Portfolio Collar product: “If we fail to perform our obligations, [you] may not receive any payment which [you] are entitled to receive from us.”
Hot Tip: Do your homework and study product disclosure statements carefully. Structured products are complex and if they perform poorly, you will be the one out of pocket, not the issuer.
Commsec capital Series Spectrum (strategy 1)
- minimum investment: $10,000
- investment term: 5.5 years
- capital protection: 100% at maturity
- income: five fixed income payments of 4% per annum
- underlying portfolio: 20 largest ASX-listed companies
- capital growth potential: up to 50% if underlying portfolio increases by more than 20% at maturity
- contact: 13 15 20, www.commbank.com.au
How they work: corporations or finance companies issue debentures. When you buy a debenture you are basically lending money to the issuer for a set period of time in exchange for regular interest payments throughout the investment period and the return of your capital at maturity.
Michael O’Sullivan, CEO of Provident Capital, says the success of a debenture relies on the strength of the issuing company. “Debentures can’t be described as good, bad or indifferent,” he says. “You have to look at the track record and the financial strength of the issuer.”
Some debenture issuers, such as the Essanda finance company, use money raised to on-lend to retail borrowers in the form of loans for products such as cars. Some issuers are rated by companies such as Standards and Poors while others are unrated and can be more risky. Make sure you understand what the issuer is using your money for. If they are involved in speculative property development, for instance, you need to question the value of any guarantees they offer to return your capital or pay a set interest rate. Generally the higher the interest rate offered by a debenture issuer, the higher the risk of losing your capital.
Minimum investment: $1,000
Maximum return: 9.5% and up
Costs: no entry or exit fees; charges for breaking an agreement before maturity will be determined by issuer.
Timeframe: 30 days to five years
Advantages: higher rates than bank products; can be traded on secondary market; if company defaults, debenture holders are paid back before equity holders, provided the company has any assets to sell
Disadvantages: higher rates mean higher risk; assessing company risk is difficult; a company guarantee is generally not as strong as government guarantee
Provident Capital Fixed Term Investment
- minimum investment: $1,000
- investment term: one month to five years
- no entry, exit or ongoing fees
- interest rate: 9.55% pa
Hot Tip: Debentures should be accompanied by a prospectus outlining product features, fees, risks, how interest is calculated and whether it meets the eight ASIC benchmarks that relate to the security and level of risk involved in the investment
4. Fixed interest managed funds
How they work: a fund manager pools money from small investors to invest in government and corporate bonds. The manager charges you a fee in return for actively managing the investment. The performance history of the fund manager should be taken into account before investing, according to Provident Capital CEO Michael O’Sullivan.
“Most managers’ websites will detail the performance of their fund since inception,” he says. “Investors should look closely at the long-term performance.”
Minimum investment: $1,000
Maximum return: 10%-11%
Costs: management fees start at 0.35% of the fund’s net asset value; establishment fees and transfer fees may also be charged, depending on fund specifications.
Timeframe: one to three years minimum suggested, but some funds can be redeemed at any time
Advantages: professional investment management (depending on the skill and experience of the manager); higher rates than other low-risk investments
Disadvantages: fees are more expensive than bank and bond alternatives; inflation can erode the real value of your initial capital; you lose control over how and where your money is invested:
Ardea Wholesale Australian Inflation Linked Bond Fund
- no contribution or withdrawal fees
- minimum investment: $10,000
- investment term: three years and up
- management fee: 0.35% of fund’s net asset value
- adviser service fee: up to 1.1%, as agreed between you and your financial planner
- the fund invests primarily in inflation linked bonds
- Contact: 13 35 66, www.challenger.com.au
5. The name’s bond
Bonds are basically tradeable debts, representing a promise by the issuer that if an investor lends a sum of money, the debt will be repaid at a pre-determined time (known as maturity) and interest paid at an agreed rate. Interest payments are known as coupons. Bonds can be issued by governments, or by companies (corporate bonds).
Hot Tip: Government bonds
How they work: the federal government issues two types of bond, usually by auction to banks and professional investors through the Australian Office of Financial Management (AOFM).
- Fixed coupon bonds: pay coupons on a six-monthly basis. The coupon rate is a percentage of the face value: a 5% rate pays $5 per annum for every $100 of face value. The full face value is paid on maturity.
- Capital indexed bonds: these bonds pay interest quarterly and their face value is indexed each year to match increases in inflation. Coupon payments increase each year in line with the newly calculated face value of the bonds. The bond is paid out at its increased value upon maturity.
Minimum investment: $1,000
Maximum return: 4.50%-6.50%
Timeframe: one to 12 years
Advantages: investment guaranteed by the government as long as bond is held until maturity; a government less likely to default than a company. You receive a known return in the form of regular interest payments
Disadvantages: lower interest rates than other investments and more difficult to access for retail investors. The Reserve Bank offers an over-the-counter facility for small investors in Sydney or Canberra and the bonds can only be sold back to the RBA, potentially at a loss
Treasury Bond 119
- available for purchase from RBA
- price: $109.609 per bond
- coupon rate: 6.25%
- maturity date: April 15, 2015
NSW Government Waratah Bonds
- available directly from the State Treasury Corporation (TCorp)
- sold in amounts ranging from $10,000-$1,000,000
- available in three-year or 10-year terms
- rate of 4.25% (3-year), 5.10% (10-year)
Hot Tip: Corporate bonds
How they work: a company may issue corporate bonds to raise funds for expansion, or make acquisitions. Like government bonds, they feature fixed or floating rate coupon payments, but the guarantee on your capital may not be as solid as a government bond. You should refer closely to the prospectus issued by the company, which outlines company information, as well as the features of the bond.
Corporate bonds suit people wishing to be a banker to a company, rather than being an owner by holding equities, according to Andrew Gordon, director fixed income research, Fixed Income Investment Group (FIIG) Securities Limited.
“If you’re the banker you’re worried about getting your interest paid and money back,” he says. “If you have equities, you’re worried about the future growth prospects of the company.”
Minimum investment: $50,000-$500,000
Maximum return: Some companies offer 10.5% or higher
Timeframe: one to 10 years
Advantages: potentially higher rates than government bonds and cash-based products; able to be sold on secondary market; if the company defaults, bond holders are paid back before equity holders.
Disadvantages: difficult for retail investors to access; a $500,000 minimum investment is common; company credit details are made available to brokers and institutional investors, but not usually to retail investors, making it difficult to assess investment risks. A higher coupon rate means higher risk. The main risk is that the company issuing the bond goes out of business.
Hot Tip: A company is better placed to meet its financial obligations if its earnings are greater than its interest expenses
Fixed Income Investment Group (FIIG) offers the following bonds, issued by well-known Australian companies:
Telstra fixed rate bond
- minimum investment: $50,000
- maturity year: 2020
- coupon rate: 7.75%
- recent trading price: $107.85 per bond
- yield: 6.56%
- no ongoing fees
- floating rate product available
Wesfarmers fixed rate bond
- minimum investment: $100,000
- maturity year: 2014
- coupon rate: 8.25%
- recent trading price: $108.25 per bond
- yield: 5.21%
- no ongoing fees
- floating rate product also available
- contact: 1800 01 01 82, www.fiig.com.au
Fast Fact: The trade-off for a capital guarantee is usually a lower rate of return. If you only get your initial capital back at the end of investment, you have lost money through inflation.