The devil is in the detail
Michelle Innis, Sydney Morning Herald, 19th of April 2006
Cash, debentures, online accounts and term deposits ... It pays to shop around when it comes to investments.
Investors with spare cash and a desire to see it invested wisely need to think hard about an old adage: the devil is in the detail.
"Generally speaking, the better known the institution, the more secure your money," says Dr Nick Coates from the Australian Consumers Association. "But it's what's in the fine print that counts."
When it comes to cash investments, such as traditional term deposits or cash management accounts, it's worth shopping around as competition is stiff.
Generally, you can expect between 5 and 6 per cent, depending on whether you stick your money in an at-call online savings account or lock it away in a term deposit.
Online accounts offer 5.25 to 6 per cent, while the rates for term deposits range from about 3 per cent to almost 6 per cent depending on the money you have and the term of the deposit (see table below).
Although you can get higher returns elsewhere - with debentures, promissory notes and income securities - they come with higher risk.
While higher returns equal higher risk, what is a higher return? Is it 2 or 3 percentage points above the Reserve Bank's cash rate, currently 5.5 per cent? The official cash rate is the benchmark lending rate for all financial institutions.
"Start looking at what banks offer on term deposits," says Jennifer O'Donnell, the Australian Securities and Investments Commission's executive director of compliance. "Once you start to move away from those rates by even 1 or 2 percentage points, there is a reason for that. Once you get to 3 or 4 percentage points, the investment is much riskier."
O'Donnell says strong regulation offers a high level of protection for bank customers. The same is not afforded to other companies offering promissory notes, debentures or other cash securities.
But if you're not satisfied with a term deposit that might pay 5.7 per cent for $20,000 for a two-year term, there are other options.
Most planners say they steer well clear of promissory notes. "It is generally not secured against any asset," says Todd Karamian from Bluepoint Consulting. He has recommended debentures to clients in the past. "But we are very careful." Debentures offered by Esanda, for example, a finance company that is a wholly owned subsidiary of ANZ Bank, offer a reasonable rate of return.
Gordon Thoms, the practice principal at Godfrey Pembroke, Melbourne, says investors must assess investments to determine the ability of the borrower to repay the capital and interest.
"Some of these developers that are offering higher rates of return can't get their money from a bank," Thoms says. "They use new investments to pay interest to borrowers who entered into the schemes at an earlier date.
"They are marketed like term deposits for one- or two-year terms. But the money is on-lent to property developers; it is not spread across a range of assets."
Some companies that want to raise money issue debentures via a prospectus. Not all debentures have the same level of risk. Investors have to rely on the financial strength of the company and the security offered. "The bottom line is that the level of risk sometimes does not justify the extra return," Thoms says.
One way to boost savings income, Thoms says, is to look at a bank's online savings accounts. The rates on offer are close to term deposit rates but these accounts, such as ING's Savings Maximiser, give access to your money seven days a week, 24 hours a day. Interest is paid at 5.4 per cent on the first dollar deposited and there are no bank fees or charges at ING.
"Your money is at call," Thoms says. "You get access and a good rate." If the Reserve Bank decides to raise interest rates, investors will benefit. It is likely that these online savings accounts will also increase the rate of interest paid. But if you're locked into a two-year term deposit, your rate won't rise.
Wealth Partners Financial Solutions planner Andrew Heaven says another way to access higher returns is to buy into a managed fund: "You can get into a good fixed interest fund, offered by a range of good fund managers, and those funds will include debentures and other assets."
Also worth looking at are bank specials on term deposits, he says: "Sometimes banks will have a whole lot of fixed-term or fixed-interest securities that are maturing and they want to get deposit levels up.
"One bank might offer a slightly higher return on a term deposit to attract those funds."
Investors should lock into a term deposit only if they believe rates are falling. Locking in means your rate will stay the same for the term no matter what other market rates do.
But Grange Securities' director of economics, Stephen Roberts, says, if anything, the pressure on rates is upward.
"Things are well balanced at the moment. But if the economy continues to gather pace, then it will hit capacity constraints, including a lack of skilled workers, which could force the Reserve Bank to lift the official cash rate." Roberts says another tell-tale sign for investors who want higher returns but who want to limit their risk is to look at the credit rating assigned to investments.
International rating agency Standard & Poor's assigns a high-level A1+ rating to Esanda's debentures for terms of one year or less and a rating of AA- for terms greater than a year.
Roberts says some big insurance companies, such as IAG, offer insurance income securities with relatively high credit ratings. These securities are hybrids, which means they can be converted from debt into equity later. They may offer interest at close to 6.5 to 6.75 per cent, which is only slightly higher than interest rates offered on online savings accounts.
"They are relatively short-term securities; they have pretty high credit ratings and they provide a good margin given the risk is not that high," Roberts says.
He adds anything with a single A credit rating or an A- is a good risk.
"A single B credit rating means you have to be much more careful. You can also look at the history of a company's credit rating. Has it deteriorated? Or improved? That will also tell you a lot about where you're investing."
And companies without a rating? "There are costs associated with getting a rating," he says. "Some companies might not have a rating because of that.
"If you are an experienced investor, you can look at Standard & Poor's methodology and apply it to an unrated company. But, for everyone else, a rating can be important because it is an in-depth assessment."
