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There is a long-held belief that fixed interest investing is low risk and low volatility. That would mean, there is little chance that an investor could lose any of their investment capital or suffer any severe fluctuations in their investment value during the investment life.
The short answer is, it depends. First, let’s deal with investment volatility.
Investment volatility occurs when any investment can be bought and sold freely during the life of the investment. Typically, investments listed on a stock exchange can be easily traded, but this can create volatility in the value. Also, the price it is traded for is not always representative of the true value of the investment. The ability to gain access to your money on a short-term basis is called liquidity.
Unfortunately, investors often sell liquid assets for less than they are actually worth if they are particularly keen to gain access to their money. This includes fixed interest.
The reasons for this are wide and varied. Common examples include:
At Hewison Private Wealth we tend to use liquid fixed interest for re-balance purposes where opportunities may exist in other asset classes.
Liquidity is a double-edged sword. It provides quick access to your money, but it can be problematic if in turn an asset is sold at a discount. We have seen this in some examples throughout COVID-19.
Many fixed income options in the market are illiquid, which means an investor is only entitled to their capital at an agreed end date of the investment. This may provide certainty, but the capital is locked up, such as a first secured mortgage, or term deposits.
Fixed interest risk is the “risk” that a borrower won’t repay. An Australian Government bond is viewed as the lowest risk fixed interest investment available. But given its low risk, it generally pays the lowest interest rate.
A number of factors impact the categorisation of risk. Generally, risk assigned to a fixed interest investment relates to the health and stability of the borrower, and how the lender ranks as a creditor of the borrower if they go into administration. The unhealthier the borrower and the lower you rank as a creditor, the higher the risk and the higher the income return should be.
Government bonds are traded on the market, so although they are viewed as almost risk-free, they can be volatile. Conversely, a first mortgage investment provides a higher level of income but is capital stable.
There are a number of ways an investor evaluates “risk”. It means different things depending on your needs. Liquid and illiquid investments each have their pros and cons and therefore can be seen as risky to one investor, but safe to another.
Fixed interest investment can be a little trickier than many believe due to volatility and liquidity issues and the desire to obtain higher rates of return, particularly in this very low-interest rate world.
The key is to understand all the characteristics of what you’re investing in. This includes knowing the impact of liquidity and potential volatility, whilst not forgetting that volatility does not mean you have lost money. Typically, fixed-income investments have a maturity, and if you’re not planning to sell early you should expect to see income flow in and your capital returned, regardless of what may happen in the short term.
Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email email@example.com or visit www.hewison.com.auPlease note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.