Mark Bouris looks at variable vs fixed interest rates and what's better for you
The events of the past month have showered us with important financial issues: sovereign debt, government default, downgraded credit ratings, market panic and credit market liquidity.
For most readers, these really come down to interest rates. However, I'd like to argue a broader point that affects everyone, and that is the issue of what is happening to superannuation and its reliance on equities markets. We should be looking at this because the superannuation industry is as large as the mortgage lending market, with around $1.2 trillion loaned/invested. Respected economist Chris Joye has been writing about this lately and the thing that leaped out at me was the OECD figures for pension/super funds which showed that Australian super funds had the highest reliance on equities of any developed country. Aussie super funds, according to OECD, have more than 50 per cent of funds under management in global and domestic shares.
The USA is slightly over 40 per cent and Canada is a little more than 30 per cent exposed to equities markets. One of the most important aspects of any good investment portfolio is diversification. That is, you don't put all your money in property, shares, cash or art. You allocate your portfolio so that when one asset class is having a rough time, another will be on a growth cycle. So why are Australians not as educated about the fixed interest markets as they are about equities? Fixed interest is the obvious foil to the volatility of equities.
Fixed interest basically covers corporate and government bonds: the bond issuer pays you either a fixed interest rate for a set amount of time (2, 3, 5, 10 years) or they are paying a floating charge, not unlike a variable rate mortgage. Either way, you receive the interest payment as income. Fixed interest investments are low on volatility, they offer certainty of returns and they are a 'first ranked' debt. If the borrower gets into trouble, bond holders are the first to be paid. How well do they perform? One of Chris Joye's graphs shows asset class 'risk and return' from 1982 to 2010. Aussie equities accumulated annual returns of 13.3 per cent over this time but they had volatility of 19.7 per cent. Australian 10-year bonds' return was 11.7 per cent, with volatility of just 8.7 per cent. And global equities returned 10.4 per cent and had volatility of 14.7 per cent.
This risk-return profile not only suits many Australians when it comes to their nest egg, but it could also act as a balance against equities in a portfolio. So think about diversification and have a look at fixed interest for your super allocations. But don't take my word for it - getting expert advice is probably the best investment of all.
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