Why are fixed interest investments falling?
April 21, 2022
Market volatility has been part of life for the past couple of years with the pandemic, and now with geopolitical tensions and the invasion of Ukraine, causing instability in the Australian and International share markets. Until the latter part of 2021 the Fixed Interest option seemed to provide a shelter from this volatility, but it is now showing the impacts the various economic events. So, why has this happened?
Firstly, what are Fixed Interest investments?
In simple terms, Fixed Interest investments are bonds and debentures which are used to loan money to governments and large companies in exchange for interest payments. These loans are typically for a fixed period of time and pay an interest rate that is set at a fixed level at the start of the loan.Where do the returns come from?
Over any period of time, the return on Fixed Interest investments comes from two main sources.
- The interest payments received. For example, if a $100 loan is made at an interest rate of 2% per annum, then the interest payment will be $2 every year.
- Changes in the price at which the loans can be sold to other investors . These market prices tend to fluctuate depending on the general market outlook, the prevailing level of interest rates as well as the specifics of each investment.
The big question. Why are Fixed Interest investments falling?
Fixed interest investments are currently underperforming because interest rates are rising. It sounds counter-intuitive, but for fixed interest investments, when interest rates rise their market value goes down.
Think of it this way: Let’s assume that interest rates are 2% and you invest $100 in a loan that will pay you $2 every year for the next 5 years.
If interest rates drop to 1%, the loan will still pay $2 a year which makes it more valuable because investors now need to invest more than $100 to generate $2 worth of yearly income.
On the other hand, if interest rates increase to 3% your loan will be worth less. No investor would be prepared to pay $100 for an investment that only generates $2 of income every year when they could be getting $3 of income for a $100 investment elsewhere in the market.
Why are interest rates rising?
Interest rates are rising as a result of concerns about inflation. One of the key jobs of central banks (such as the Reserve Bank of Australia) is to keep inflation at an acceptable level. When it appears that inflation will increase beyond this level, central banks increase interest rates to dampen economic activity and bring inflation down.
What’s the best investment option right for me in the current market?
We recommend that you seek advice from a professional financial planner before making investment decisions. An Adviser from TelstraSuper Financial Planning can help you determine what option is best for you depending on your risk-return profile. This type of advice is included in your membership so there is no additional cost. To make a booking simply call 1300 033 166 or contact us online.