Over the last couple of years fixed interest investments have been attractive alternatives for many investors. Share markets have been responsible for a lot of anxiety so, quite naturally, there has been a growing trend for people to choose less risky investment options. There are numerous choices in the fixed interest arena. Having some basic information is always a good start when it comes to making informed choices.
Set term or flexible?
Not all fixed interest investments involve locking up funds for set period of time. Bank term deposits and debentures generally involve a commitment for a set time frame but tradeable fixed interest investments, usually referred to as “bonds” or “notes”, allow investors to sell prior to maturity.
Bonds and notes range from New Zealand Government and local authority stock to investments issued by large companies. They have a date for maturity and a set rate at which the interest is paid, generally twice yearly, with tax deducted at source. Of course, if the holder has an exemption from paying RWT, the gross income is paid. Bonds can be held to the maturity date or sold prior to that time.
A word of caution: the price at which you buy or sell a bond will depend on what’s happening to interest rates at the time. If interest rates move down, bonds move up and vice versa. The price change is actual ONLY if you are selling or buying but will be shown on your portfolio valuation report (where they are a “paper” loss or gain).
Interest rates moving up or down?
Having some idea about which way interest rates are likely to move is very important. When interest rates are falling, locking in a higher rate of return in a term deposit or debenture makes sense if you don’t need access to the capital prior to maturity. If interest rates are moving up, it may be better to keep the amount available for investment in cash or in very short term investments so that the funds are available to take advantage of higher rates when they become available.
It’s vital to have an idea of interest rate movements where bonds are concerned especially if you are considering selling prior to maturity. An interest rate hike can have severe consequences for bonds. Right now, with the world economy showing lacklustre growth, interest rates are very low indeed. New Zealand’s situation aside, on a global basis, the “risk” that rates will rise is increasing. Here in New Zealand, we have just been through a period of strong growth and our interest rates are moving down. That’s making bond prices move up – more expensive to buy or a “paper” gain for existing holders.
Here is an example of how a bond can change in price. Between April 7th and May 6th interest rates moved downwards and the bond price moved up.
New Zealand Government Stock
Maturity date 15/04/2013 Coupon* 6.5%
Cost to buy $10,000 worth on 7th April $10,362 (Excluding accrued interest. Yield 6.01%)
Cost to buy $10,000 worth on 5th May $10,515 (Excluding accrued interest. Yield 5.81%)
* The rate of interest paid on the face value amount of bonds – i.e. $10,000 in our example.
Brokerage rebates
When clients purchase debentures via a Portfolio Management Account with Capital Financial Planning Ltd they receive back any brokerage paid to the Company, either as a direct cash payment to their cash account or by way of an enhanced annual return.
An example is St Laurence Property and Finance’s debentures which were issued recently. A client invested $40,000 for 4 yr. at 10.50%. We paid $1,200 into the client’s cash account as brokerage rebated. That was 3% of the amount invested ($40,000). Spread over 4 years it works out at an additional 0.75% per annum.
