In this guide
In a nation where property investment is a national sport and the sharemarket plays a starring role on the nightly news, cash and bonds are decidedly less glamorous.
But recent experience of high inflation and interest rates changed the investment landscape and raised awareness about the importance of defensive assets to provide stable income with a high degree of safety.
Cash and 10-year government bonds are considered ‘risk-free’ and are the yardstick other investments are measured against when weighing up the risk you take for the returns on offer.
Cash may not be king but it has been providing attractive income after years in the doldrums although you will need to look beyond bank savings accounts to get the best returns.
Inflation is the natural enemy of bonds because bond prices fall as interest rates rise, but the prospect of lower inflation and more interest rate cuts in 2025 is altering the investment equation.
There are various ways you can access bonds and other fixed interest investments. While they may all be lumped in to the ‘defensive’ part of your portfolio, there’s a wide variety of risk and return on offer.
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Cash
While the official cash rate remains high, bank high-interest savings accounts are still offering attractive interest rates – above 5% in many cases at the time of writing, although the terms and conditions can be restrictive.
Some things to watch out for are a high introductory rate that reverts to a lower base rate after a few months, minimum monthly transactions, and a requirement to grow your balance each month.
Increasingly, investors are looking beyond bank accounts to diversified cash exchange-traded funds (ETFs). These ETFs invest in cash products and deposits offered by reputable banks, often at better rates than you could get at your local bank, but there are differences in the underlying investments in each so it’s important to check this and other information on the issuer’s website.
Instead of the rigmarole of opening a bank account, with often limiting conditions, or locking your money away in a term deposit, you can buy and sell an ETF on the Australian Securities Exchange (ASX).
Distributions (interest payments) are paid monthly.
On the downside, unlike bank accounts, cash ETFs don’t enjoy the government guarantee for deposits up to $250,000.
The table below shows the biggest and most popular cash ETFs, fees and returns, but is not a recommendation for any product.
| ASX Code | Base fee | 1-yr return | 5-yr return p.a. |
|---|---|---|---|
| AAA (BetaShares) | 0.18% | 4.54% | 2.14% |
| BILL (iShares) | 0.07% | 4.59% | 2.02% |
| ISEC (iShares) | 0.12% | 4.75% | 2.15% |
Source: Issuer websites as at 8 January 2025
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Find out moreAAA is by far the biggest and most liquid of the three. ISEC is higher risk with potentially higher returns than the others as it can invest in higher yielding securities like floating rate notes and commercial paper. All three currently offer yields of around 4.4–4.5%.
Term deposits
Term deposits have long been a popular way to lock in guaranteed income at a fixed interest rate for a set period of time. For SMSF investors in retirement phase, they also allow you to manage your future cash flow by staggering the maturity dates of multiple term deposits.
According to SMSF administration service provider, Class cash and term deposits are the third most popular asset class by value with SMSF investors in 2024 (15.2%), after Australian shares (28.3%) and direct property (21.1%).
Term deposits are readily available for terms of one month to five years. Generally, the longer the term the higher the interest rate and the best rates tend to be offered by smaller banks and financial institutions.
At the time of writing, the best rates for one-year term deposits are around 5%, well above inflation of 2.3%. The big four banks are offering rates of between 4% and 4.4% for one-year term deposits.
As well as the interest rate and term of the deposit, other things to look out for when choosing a term deposit are:
- Payment options – some lenders offer interest payments monthly, biannually or annually, but you may get a better return if you opt for payment when the term ends
- Penalties apply for early withdrawal, and vary depending on the lender
- A linked bank account is required by some banks, while others allow a stand-alone term deposit using your own bank account.
Pros
No set-up or account-keeping fees, no monthly account conditions or deposit requirements, and a government guarantee for deposits up to $250,000.
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Cons
You won’t benefit from rising interest rates during the term of your deposit, but you will benefit from locking in a higher rate if rates fall, so try and match your term to expectations about future interest rates. Rates can be lower than high interest savings accounts and penalties for early withdrawal limit flexibility.
Bonds
A well-diversified bond portfolio tends to offer reliable income payments with less volatility than shares and a better coupon (interest) rate than cash investments as a reward for holding your bonds to maturity.
However, the defensive role of bonds was tested in recent years as a rapid rise in inflation and interest rates resulted in extreme market volatility.
The interest rate (yield) on 10-year government bonds spiked as central banks jacked up official interest rates to stem inflation. That’s good news for investors who intend to hold their bonds to maturity.
Ten-year government bonds issued by stable, credit-worthy governments are viewed as ‘risk free’ because the government guarantees to pay you back when the term expires. The yields on 10-year government bonds were 4.58% in the US and 4.41% in Australia at the end of December 2024.
However, if you sell your bond before maturity you’ll get the market value, which could be higher or lower than face value. Because bond prices fall as yields rise (and vice versa), rising interest rates have pricked the bond market bubble that inflated in the era of easy money between the GFC and COVID-19.
Despite the uncharacteristic volatility, there’s always a place for bonds in a diversified portfolio. What’s more, now that central banks have begun cutting interest rates with more cuts expected in 2025, investors who have locked in a high rate for the long term will be sitting pretty. The Reserve Bank of Australia (RBA) is an outlier, but it too is expected to lower the cash rate in 2025.
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Find out moreBroadly, there are two categories of bonds:
- Government bonds issued by Australia and other nations under various names, for example, US Treasuries, UK Gilts and German Bunds. In Australia, semi-government bonds are also offered by state and territory governments.
- Corporate bonds issued by large companies offer higher yields with higher risk than government bonds because payments are not guaranteed in the event of a corporate failure, so the creditworthiness of the issuer is extremely important. Other types of corporate bonds such as mortgage-backed securities and private debt offer even higher yields with higher risk.
As it’s difficult for individuals to achieve a diversified bond portfolio with direct investments in bond issues, which often require a large minimum investment, most individual and SMSF investors access bonds via managed funds or exchange-traded funds (ETFs).
You can buy managed funds or ETFs in specific types of bonds such as government bonds, high yield bonds, mortgage or private debt, or a diversified bond portfolio. Actively managed funds generally have higher fees than ETFs that track an index.
Pros
Bonds traditionally offer reliable income with less risk than shares. As interest rates and bond yields fall, and bond prices rise, investors could get capital appreciation as well as income from their bonds. Happy days!
Cons
Inflation is the enemy of bonds, as rising inflation feeds into higher interest rates and falling bond prices. Even at their peak in 2023, yields on 10-year bonds were below inflation. When buying corporate bonds, it’s imperative to understand the risk profile of the underlying companies.
Hybrids
Hybrid securities, as the name suggests, combine features of shares and bonds. They offer regular income like bonds, but their value can fluctuate like shares.
Hybrids have been extremely popular with Australian investors because of their relatively high yields and the household names issuing them, notably the big four banks. At the time of writing, bank hybrids listed on the Australian Securities Exchange (ASX) had running yields of 7% to more than 8%.
However, the Australian Securities and Investments Commission (ASIC) Moneysmart website warns they are complex products with risks that investors need to understand before parting with their money.
In September 2023 the Australian Prudential Regulation Authority (APRA) announced a review of hybrids following a handful of overseas bank failures earlier in the year raised alarm bells because of the large number of individual and SMSF investors in Australian hybrids. In December 2024, APRA announced bank hybrids will be phased out between now and 2032, deeming them too risky in the event of a crisis.
Hybrids generally pay a fixed or floating rate of return until a specified date, but as Moneysmart points out, there’s no guarantee on the amount and timing of interest payments. As each hybrid issue is unique, it’s important to read the prospectus for details and consider getting independent financial advice.
- Banks can convert their hybrid issues – also called Tier 1 capital – to shares if they get into financial difficulties. The shares may be worth less than your initial investment or written off completely, protecting the bank’s depositors at the expense of hybrid investors.
- Listed and unlisted companies can also issue corporate hybrids, generally referred to as ‘subordinated notes’ because hybrid investors get paid last if the company becomes insolvent. Companies can also defer interest payments and the return of your capital.
Investors can purchase individual hybrid issues or gain exposure to a portfolio of hybrids via a managed fund or ETF. Some diversified bond funds also include hybrids.
Pros
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Hybrids offer attractive income and are issued by major banks and other companies.
Cons
Unlike bank deposits or Australian government bonds, hybrids are not government guaranteed. Interest payments can be deferred, hybrid investors are often last to get their money back if the issuer becomes insolvent, and the security can be converted to shares if the issuer gets into financial trouble.
The bottom line
Cash, term deposits, bonds and hybrids provide reliable income and diversification for your investment portfolio. Bonds and hybrids are not well understood, so it’s important to do your due diligence and research the creditworthiness of the issuer, or the underlying investments in a managed fund or ETF. Because of the complexity of many products, it may also be worth considering independent financial advice.
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