Australian seniors and self-funded retirees are not alone when they see their incomes diminish because of low interest rates. Traditionally Australian retirees have either invested in term deposits or direct property, with income from each helping to fund retirement lifestyles. Government IPOs of publicly owned assets like Telstra, Commonwealth Bank and more recently Medibank Private has seen a growing cohort of these investors enter the stock market. But in a low interest rate world, where the bulk of these portfolios are earning sub inflationary returns, what are some other options?
The great risk and return trade off
Finance 101 always covers concepts of risk and return. What is meant by this is if you want to earn 20% on your investment, you are probably risking a substantial part of your initial investment in the process. You need to make sure you are comfortable with what you are investing, the period of time your money is tied up, and the return on offer. Other factors like your age and cash requirements should also be considered, and that’s where investment professionals can help you navigate the investment universe.
(Source Westpac )
The following are some examples of how you can invest, or what we term “asset classes”;
In the low risk part of the spectrum are cash and term deposits . Investments of $250,000 or less with one Australian Deposit-taking Institution (ADI) usually attracts a Government Guarantee ( see here for more details ). The risk is therefore pretty low, but so is the return of anywhere around 0-3%.
Bonds are the next leg up and are IOU debt obligations of an issuer which could be a government, state government, bank or even a corporation. The risk is the issuer defaults, and you join the queue of creditors wanting their money back. Returns here can be a few percent on top of cash and term deposit rates, but dependent on the term of the bond, and how risky the issuer is.
Investing in hybrid securities is not the same as investing in term deposits or bonds. These securities carry greater risk, and in some instances a Bank can convert them to shares, or even write them off. In the meantime, they tend to pay regular distributions which may include franking credits. It’s these characteristics which make them a “hybrid” of the debt of an organisation, and the equity. Returns here can be around 5-7%.
Publically listed shares (or equities ) are typically traded on an exchange like the ASX. Buying a share means you own a small amount of a particular company, eg like Commonwealth Bank (CBA) or overseas like Apple or General Electric. Being a shareholder in a company means you get to have a say in how it is run at an Annual General Meeting, and get a share of the profits (if there are any) via dividends. It also means if a company fails (like Babcock & Brown), that you may lose everything. Creditors such as bond holders will be paid before you get anything back on your investment. Shares in Australia typically pay around 4-5% in dividends, and then if a company is doing really well, can pay another few percent in capital growth. Shares over time tend to experience a 1 in 5 year negative return.
Some retirees just seek stocks that pay high, fully franked dividends. The following chart illustrates why… but they must be comfortable that they are risking their capital when investing in shares.
Other options include structured products which can be reasonably simple and with a view to protect a certain amount of your investment, or more complex. Returns vary, and depend on what the product is trying to achieve etc.
Wholesale and sophisticated investors can access other opportunities like property syndicates which may pay an income of 8%+ with capital gains. Or other alternative investments which may include development risk or private equity investing can produce returns of 20%+. They can also lose.
One thing you should always keep in mind is not to keep all your (investment) eggs in the one basket. While returns on investments are additive, risks aren’t necessarily so. Some asset types like shares behave differently to cash or term deposits. Equally having all you investment in one company like CBA shares means you have increased risks if that company doesn’t perform as well as others. If you don’t have time to pick the right stocks, some investors outsource this to fund managers.
Remember to diversify your investments, and seek professional advice if you don’t know what to do or where to start.
