Don’t squander these high interest rates

When it comes to investments, shares and property get most of the attention.

However, there’s another very large asset class that flies under the radar, at least in mainstream discussions.

Fixed income is equally as important to the average investor, making up almost 50 per cent of total KiwiSaver assets and somewhere between 20 and 40 per cent of the typical diversified portfolio.

Fixed income (or bonds, as finance people will say) encompasses everything from government or local authority debt through to corporate bonds and term deposits of a reasonable maturity (let’s say 90 days).

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When you invest in fixed income, you become a lender to the entity in question.

You allow it to use your capital for a period, and at the end of that time it will be returned to you in full.

Along the way, you’ll be paid an interest rate that is commensurate with the level of risk you’ve taken on.

Governments and local authorities are the safest entities (because they can simply increase taxes or rates if they need to), which means they usually offer the lowest interest rates.

Corporate bonds are slightly riskier, because the ability of a company to pay back its debts depends on the health of its business.

When it comes to fixed income, getting your money back is paramount. Don’t put your capital at risk for a few measly per cent of yield.

Anything that looks too good to be true probably is, so if in doubt talk to an investment adviser.

Fixed income won’t offer the long-term growth you’ll get with shares, private businesses or property, but it’s an important part of a portfolio for many investors.

It provides regular, predictable income, as well as stability during uncertain periods.

Having said that, fixed income prices can still fall, as they did during 2021 and 2022. This isn’t a common occurrence, and these were the first declines for corporate bonds since the 1990s.

It wasn’t because governments or companies defaulted on their obligations, nor does this mean those investors won’t get their capital back (in full) upon maturity.

When interest rates rise the price of existing bonds tends to fall, and when interest rates fall prices rise.

Bonds have been doing it tough since the pandemic, with interest rates moving sharply higher from near-zero levels.

However, a tipping point may soon be upon us, and those headwinds might become tailwinds.

The Official Cash Rate is at its highest since 2008, while wholesale interest rates last week hit levels not seen in 13 years.

This trend won’t be welcomed by highly indebted borrowers, but conservative investors looking for steady income are facing the best opportunities in more than a decade.

That’s especially so if you believe we’re close to the end of the interest rate hiking cycle, or that a more difficult economic period is looming.

It’s difficult to say if where the peak is, but interest rates typically reach their highs around the time of the final central bank increase.

Short-term bank deposits are offering great value right now, but this time next year interest rates could well be lower than they are today.

If that happens, some savers might find themselves facing much less attractive reinvestment rates.

In contrast, one can generate a yield of more than six per cent from a high-quality fixed income portfolio, with maturities in the range of two to five years.

It makes good sense to lock in this income at current rates, and make hay while the sun is shining.

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