How does it work?
- An investor lends money, known as the principal, to a borrower or issuer
- The issuer makes payments in interest, or coupons, to the investor of either a fixed amount, or an amount linked to a moving benchmark; income payments are made on a fixed schedule of dates
- The issuer pays back the principal on a fixed date, which is the end, or maturity, of the investment
A term deposit can be a secure way to invest and a potentially handy solution if you’re concerned about interest rates dropping in the coming months or years.
Your money is in a deposit account for a certain agreed period of time, known as the ‘term’.
An interest rate is locked in for that term so you know the interest you’ll earn on your initial investment amount.
Term deposits can’t be traded like shares, exchange traded funds (ETFs) and exchange traded bonds (XTBs), but they have a fixed life and can provide regular income during that life or at expiry.
Term deposits are one of the lowest-risk investment opportunities, particularly because the government guarantees term deposits up to $250,000 with an Authorised Deposit-taking Institution (ADI).
Australian Government Bonds
The Commonwealth of Australia issues bonds called Commonwealth Government Securities.
They have a predictable cash flow paid on a periodic basis with a specified maturity date.
They can be traded on the Australian Securities Exchange (ASX) in the form of exchange traded Treasury bonds and exchange traded Treasury indexed bonds through a financial advisor, stockbroker or through an online trading account, such as CommSec.
They are low risk, because you receive the face value of the bond if you hold it until maturity.
They provide regular income and they are easy to buy and sell on the ASX.
If you want to sell the bond before maturity, the market price can go up or down depending on the amount of time left until maturity, interest rate expectations and changes to the official cash rate set by the Reserve Bank of Australia (RBA).
For example, the Australian government’s benchmark 10-year bond touched a record low after the RBA cut the cash rate to an unprecedented 1.5% in August 2016.
Bond prices rise as the yield drops, which can occur when the cash rate falls (or the expectation is that it will fall) or when market sentiment increases demand for safe assets.
You can invest in government bonds, either domestic or global, through exchange traded funds (ETFs) or a managed fund to add diversity to your portfolio. An ETF can be a low-cost way of spreading risk across asset classes and can provide some protection against volatility, while a managed fund actively manages to seek higher returns by opportunistically buying and selling bonds.
Using an ETF or managed fund provides access to markets that might otherwise be difficult to enter and enables your portfolio to diversify beyond the Australian economy to gain exposure across regions at times of global economic uncertainty.
Companies have several ways to raise money from investors to finance business activities.
One way is to issue bonds that pay you interest and pay back the principal money you invested on a certain maturity date.
Because you are lending money to the company, you are a creditor, so you stand in front of shareholders for any return if the company goes into voluntary administration. However, there is no guarantee you would get your money back, if that were to occur.
Many investors, including SMSFs, have traditionally invested more than 50% of their funds in cash and Australian shares, with little exposure to fixed-interest investments such as corporate bonds.
Corporate bonds can provide a regular income and higher interest rates than what might be available on term deposits, other cash-based products or government bonds, and they carry less risk than shares.