What do you know about fixed interest?
Fixed interest has been one of the best-performing asset classes over the last five years. But what does investing in it actually mean?
If your super is invested in a ‘balanced’ or ‘conservative’ option, there’s a good chance you own some fixed interest investments. Fixed interest (often called ‘bonds’) is one of the four main investment asset classes, along with shares, property and cash.
What are fixed interest investments?
They are a way for large organisations, and even governments, to raise money from investors (effectively, lenders) rather than taking a loan out with a bank. In return for borrowing this money, the organisation agrees to pay interest to investors over the term of the loan.
Types of fixed interest investments include corporate bonds, government and semi-government bonds and other income securities.
Generally, the better the credit risk of the organisation to which the money is lent, the lower the level of interest it pays. For example, government bonds generally pay lower interest rates than other bonds.
How is your money invested?
If some of your money is invested in fixed interest within your super, the process generally goes like this:
- Your money is pooled with that of other super investors and buys you a set number of units. How many units you get depends on how much money you invest and the unit price on the day you invest.
- The investment manager uses the pool of money to buy fixed interest investments (effectively, using it to make loans to the issuer of the investments).
- Unit holders are entitled to a share of the interest income generated by the loans the investment option makes – which when invested via super, are reinvested to buy you more units, thus growing your overall investment.
- The value of your units (and hence your super account balance) can go up and down depending on things like changing interest rates, a change to an organisation’s credit risk, and shifts in supply and demand for the investment.
Why invest in fixed interest?
Fixed interest investments can offer the following benefits to your superannuation portfolio:
- Income. The interest payable on your investment provides regular income, most of which is reinvested to increase the value of your investment.
- Diversification. Fixed interest investments tend to behave quite differently from growth assets (eg shares and property), so they can be a good way to reduce risk and smooth returns on a diversified portfolio.
- Protection against falling interest rates. When interest rates drop, the returns from cash tends to drop with them. By contrast, lower interest rates actually push up the value of fixed interest investments.
It’s very important to note that although fixed interest is generally classed as a more ‘conservative’ investment, it nonetheless goes through investment cycles and at times its returns, like those of shares, can be much more volatile and even negative.
Want to know more?
Like any financial decision, an investment in fixed interest should be looked at in the context of your whole portfolio and your long-term goals. Your financial adviser can help.