AMP Capital's Craig Keary warns investing in term deposits may prevent investors reaching their financial goals and suggests other ways to find yield.
Uncertainty across the globe is significantly impacting the financial markets. Volatility is causing many investors to re-think their investment strategies.
Many are straying from their set investment plans to satisfy their very human emotional need for security, especially during times of uncertainty.
However, what many may fail to recognise is that by investing 100 per cent of their monies into the traditional safe haven – the bank term deposit – for longer than 12 months may mean they won’t reach their financial goals for the medium and long term.
So, how can investors more likely reach their financial goals in these constantly changing times?
Falling bank term deposit rates
In Australia, market volatility has caused many investors to move significant proportions, if not all, their monies to more conservative investments such as bank term deposits.
However, as Chart 1 illustrates, bank term deposit rates are not stable over time and can fall quickly. They have been in a downward trend for over the last 20 years.
Recently, they have been falling with the Reserve Bank of Australia official interest rates.
With falling bank term deposit rates, it’s difficult for investors to keep up with inflation over time.
As shown in Chart 2, a top marginal taxpayer making a 100 per cent allocation to bank term deposits, starting at any time in the last 20 years, would have failed to keep up with inflation.
Many medium- to long-term bank term deposit investors may not adequately meet their future costs of living.
Bank term deposit investors – particularly those who are fully invested in bank term deposits for over 12 months – need to know the importance of growing their capital’s value to meet their cost of living over time.
Sourcing yields outside of bank term deposits
While bank term deposit yields are falling, advisers should consider a variety of other sources for yield to meet their clients’ needs.
As Chart 3 shows, there are attractive alternatives for yield in Australian shares, corporate bonds, unlisted non-residential property and REITS in comparison to bank term deposits.
Australian shares
Australian shares are offering a higher income stream than bank term deposits, as shown in Chart 4.
The grossed-up dividend yield on Australian shares is approximately 6.5 per cent.
This means that Australian shares are generally providing a high cash flow in comparison with bank term deposits.
Of course shares come with the risk of capital loss. One way to minimise this risk is to focus on shares providing sustainable above-average dividend yields.
Higher yields provide greater certainty of returns during volatile times.
There is also evidence that shares paying high dividends are associated with higher returns over time, as retained earnings are often wasted.
Dividends also reflect confidence in actual and future earnings.
The key is to focus on those companies that have a track record of delivering reliable earnings and distribution growth over time, but are not reliant on significant leverage.
Investors need to be aware that if there is significant leverage, the yield is high only because there is something wrong with the company.
Australian corporate bonds
Australian corporate bonds are a good option for those investors wanting higher yields than government bonds and bank term deposits, but also wanting to avoid share market volatility.
For example, investment grade Australian corporate bonds – these are considered high quality – have yields from around 5.5 per cent to 6 per cent.
Lower quality Australian corporate bonds have yields that are even higher, but at a higher risk.
Australian unlisted non-residential property
There is a range of benefits in investing in Australian unlisted non-residential property.
This asset class provides stable, contracted revenue streams; protection against inflation; and low correlation to other assets in a diversified portfolio.
Before choosing a non-residential property, it’s critical that investors know their appetite for risk and the time period for which they want to invest.
These factors will determine the type of non-residential property that will best fit them.
For instance, on the one hand, it may be suitable for investors approaching retirement to invest in stable core property with little risk of capital devaluation via having a good location, high quality with significant scale and steady income distribution.
On the other hand, investors who have over a 10-year investment timeframe may be more comfortable in taking more risk by diversifying into development and value-add opportunities: a focus on more total return (capital and income returns).
Consider other assets for sustainable yields
All in all, the investment environment remains tough.
The aftershocks from the GFC are continuing, especially in Europe and the United States.
The result is periodic falls in the markets as investors run for safety – only to be reversed as new government policies swing into action.
While all this is happening, the traditional safe haven – the bank term deposit – is becoming less attractive as its yields fall.
Investors should consider other assets that have decent and sustainable yield.
These alternatives to bank term deposits can provide greater certainty of return in today’s environment of high market volatility and constrained capital growth.
Craig Keary is head of retail business at AMP Capital.
