Cash in a deposit account doesn’t necessarily equate to safety. That’s why many investors are shifting to fixed interest securities.
By any measurement, $2.8 trillion is a lot of money.
Expressed another way, it’s $2,800 billion. And it’s also the amount of money – according to Australian Prudential Regulation Authority data from January 2023 – that’s being held in millions of deposit accounts provided by Australian banks and other authorised deposit-taking institutions.
Separate data from the Reserve Bank of Australia shows that, of the total, roughly $1.6 trillion is being held in transaction accounts.
These are typically ordinary savings accounts providing people (and organisations) with quick access to their money.
A further $1 trillion is in non-transaction accounts – accounts such as term deposits, where you receive a fixed income return for effectively locking your money away for a set period of time.
For the most part, cash held in savings accounts is used for general living and discretionary expenses – to pay for mortgages, rent, food, and other everyday costs.
On the other hand, cash held in term deposit accounts can readily be classified as an investment.
It’s generally put there for periods ranging from six months to anywhere up to five years to earn a higher return than a savings account would earn if the cash was retained over the same period.
The pros and cons of cash
There is a common misconception that cash is a risk-free asset. It’s not prone to daily market volatility like shares are. As noted above, cash in a savings account is also liquid – you can generally get your hands on it quickly and easily.
Furthermore, cash savings up to $250,000 per account holder (including SMSF trustees) on deposit with an Australian authorised deposit-taking institution are guaranteed by the Commonwealth in the event the institution fails.
Yet, cash does have inherent investment risks. Firstly, a decade of record-low interest rates has meant that cash as an asset class has delivered an average annualised income return of just 1.9 per cent since 2012.
That’s lower than any other major asset class. Worse still, after taking high inflation levels into account, real cash returns have been negative for some time.
Bonds as an alternative
Investors wanting to explore other ways to invest their cash, outside of vehicles such as fixed term deposit accounts, may be interested in considering fixed interest securities.
In everyday financial language they’re referred to as bonds.
Bonds are securities issued by governments or companies that they use to borrow money.
Investors buying bonds can expect to receive full repayment of their principal if they hold it until maturity, as well as steady regular interest payments until then (similar to a term deposit).
As such, bonds are generally considered a lower-risk type of investment than shares, which can’t offer any expectations to investors of either full repayment or a steady income stream and which are usually more prone to market volatility.
Likewise, being slightly higher-risk than cash, bonds are generally expected to outperform cash over the long term.
What’s clear is that a growing number of investors worldwide are using their cash to take advantage of higher-returning, relatively low-risk, high-grade bonds, especially government-issued bonds.
That’s showing up in a range of other data, including statistics from the Australian Securities Exchange (ASX) covering monthly inflows into ASX-listed exchange traded funds ETFs that invest in Australian and international bond issues.
ETF bond funds can readily be bought and sold by anyone in the same way as listed shares, simply through any ASX-linked trading platform.
In the latter half of 2022 investment inflows into ASX-listed bond ETFs ($2.2 billion) actually exceeded the inflows into ASX-listed Australian shares ETFs ($1.6 billion) – that’s rare.
What’s attracting investors into bonds?
Three main factors have led to the increased, and accelerating, inflows into bond products around the world.
1. Higher interest rates
Rising interest rates have lifted the yields available to investors on new and existing bond issues. That makes bonds more attractive to investors seeking higher steady income streams.
Vanguard forecasts global bonds to return 3.9-4.9 per cent and domestic bonds to return 3.7-4.7 per cent over the next decade.
2. Higher capital growth
Once inflation levels fall back, it’s likely that central banks will start cutting interest rates.
Lower interest rates will likely translate to higher bond trading prices. This is another key attraction for fixed income investors with a longer-term horizon.
3. Improved portfolio diversification
Lastly, the traditional role of bonds in investment portfolios is to provide asset class diversification to help smooth out total investment returns over time.
While bonds do not generally outperform riskier asset classes such as shares over the long run, they typically have a more stable return profile because they are not prone to the same level of market volatility.
Expect to see more investors use bonds to capitalise on higher interest rates, lower bond prices, and the potential price upside from markets.
This may see a reduction in the relatively high amount of cash currently being held by many investors in low-yielding financial institution accounts.
To find out more about investing and diversification, call us on (02) 8277 4605 today.
Source: Vanguard March 2023
Reproduced with permission of Vanguard Investments Australia Ltd
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