June 21, 2019 | 02:25 AM

Savings Tips

04.07.2018Bonds: Are they an effective method for saving?

When it comes to finding a location for savings, it can sometimes seem like there's no ideal place to put your money. Find out if its worth considering bonds with FatCat.com.au.

When it comes to finding a location for savings, it can sometimes seem like there’s no ideal place to put your money. While it might seem like the safest option, keeping money in fifty dollar notes under the bed – or even in a standard bank account – actually isn’t safe at all. That’s because Australian interest rates are currently rather low: a bank is unlikely to pay interest at a higher rate than the rate of inflation, so even by being “safe” the actual amount of cash a person has can plummet. 

But with risky options like stock market investments or high-value investments like property sitting at the other end of the spectrum, it quickly becomes apparent that the possibility of hard-saved cash declining in value is very real. Bonds are, to some extent, a middle ground: rather than buying a chunk of a company as a person would with a share, a bond is essentially a loan from the saver to some other organization, with some interest paid back to the saver for the privilege. Here’s an explanation of the major types of bond and how they can help savers to preserve and grow their pot.

Bank with the government

The most obvious way in which governments raise money is through the pesky taxes they levy on the pay checks of most working Australians. But there are other ways governments make cash, too. They also borrow a lot of money, often on the assumption that it won’t need to be paid back until a new government is in office. Australian government borrowing sits in the billions of dollars – and while that may seem a little worrying, it also poses an opportunity for some.

By taking out a government bond, the saver can essentially loan the government money. Because the government can’t take the political risk of defaulting on these, they are often more secure than a private bond because the government will prioritize repayments to their voters. But the downside of this relative security is that interest rates are very low, which may render it unworthy of pursuing.

Private fixed rate bonds

The next potential choice for those who are thinking about a bond is to go for a privately-provided fixed rate bond. As the name suggests, the advantage of a fixed-rate bond is that the interest rate the saver will get paid is sorted out in advance. This means they’ll be able to work out which bonds are going to work best for them and how much they’ll earn as a result, which is ideal for those who are looking for some financial security from their bond decisions.

There is still some risk involved with fixed-rate bonds, however. Although they offer a lot of advantages, they are still vulnerable to wider interest rate fluctuations due to the fact that they require commitment over a period of months or years: once the saver has committed to a certain interest rate, they’re locked in. If they take out a one year bond at a 2% interest rate, for example, they’ve excluded the possibility that they could benefit from future interest rate rises. Of course, the inverse may also occur – and if in this example the interest rate then plummeted to 1%, the saver would benefit by having locked themselves in at 2%.

The world of bonds may seem at first glance to be a little complex, but it doesn’t have to be. Fundamentally, bonds are simple loans: the saver offers their savings up as capital, and the borrower – whether that’s a private firm or the government – has it for a fixed period of time in return for some interest. The key to bond success is to research the options and then find one that has a risk profile with which the saver is fully comfortable – and which they are happy to include as part of a responsible portfolio.

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