With interest rates so low our team is often asked “Where can I get a better return? Are bank shares with dividend yields between 5% and 6% better than reinvesting in a term deposit at less than 4%? Do I invest in a term deposit or do I buy the bank shares?” Our response is never the same because recommendations will depend upon you, your circumstances and your appetite for investment risk; both capital risk and income risk.
Share prices will rise and fall in a cycle. Over time the share price will range from expensive to cheap. It is important to focus on the future prospects of shares not on how they have previously performed. Determine your investment time horizon. Are you investing for the long-term or short-term? Will you need funds at short notice? If you believe in the long-term sustainability of a company, you don’t want to be a forced seller to fund a short-term capital need. If you require certainty of income, you need to consider if the company you invest in is capable of paying dividends on a sustainable basis. Do the dividends vary from year to year? What if they don’t pay a dividend? There are income risks with term deposits too.
For example, investors looking to reinvest a five-year term deposit now, will need to accept a 60% cut in interest rates compared to what they locked in back in 2010. Can you afford to accept the term deposit rates on offer or do you need to source higher income producing investments and accept a greater risk of capital volatility? Be wary of the income risk and understand the underlying investment you are invested in. If a term deposit is paying 3.5% and a debenture or bond is paying 5%, logic states that the higher interest rate paid is because there is greater risk in the underlying investment. To reduce investment risk, avoid having all your eggs in one basket. Investing in one stock or one sector is a high-risk strategy and not recommended. In all investments, there are risks: income risks and capital risks. Generally those prepared to accept higher risks are rewarded but you need to understand the risks and ensure you are receiving sufficient return for accepting those risks.
In all cases base your decision on your personal circumstances.
The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client. A disclosure statement is available, on request and free of charge.
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