Many investors look to cash and term deposits as an alternative to bonds, but when you delve a little deeper; it becomes clear that these investment vehicles are materially different.
Cash and term deposits can be appropriate for investors with short-term investment horizons (less than 12 months). However for longer-term investors, core bonds may be the more suitable investment, generally offering higher yields than term deposits and significantly lower volatility than equities.
Why bonds? Term Deposits are failing investors
In today’s low interest rate environment, term deposits are failing to meet the income needs of many investors. Longer-term investors, who are willing to take on moderate additional risk, can benefit from the higher yields and diversification potential of bonds.
Bonds help diversify equity risk
While bonds may be riskier than term deposits, their risk is very often inversely correlated to equity risk. This means that adding bonds alongside equities can help to minimize overall portfolio risk through diversification and offer protection against falling equity markets. Term deposits, in contrast, do not have the ability to offset growth asset losses.
Rising rates builds bond income
Bond returns ultimately benefit from rising yields as cash flows from maturing bonds can be re-invested at higher interest rates, increasing the overall yield of the portfolio. An increase in a bond portfolio’s income also helps to offset the negative impact on its declining price.
Bonds check the box on essential investor goals
Bonds have historically provided capital preservation, income and growth, and diversification due to their low correlations to equities – essential goals for many investors.
Key implications for investors
- Term deposits are failing to meet the income needs of many investors in today’s low interest rate environment. Longer-term investors can benefit from the higher yields offered by core bonds.
- Unlike term deposits, bond risk tends to be inversely correlated to equity risk, which means they offer diversification and protection against equity market downturns.
- Bond returns actually benefit from rising rates over the longer term because the cash flows from maturing bonds can be re-invested at higher interest rates.
- Bonds offer more investor benefits than term deposits, including income and growth and diversification potential, making them a smart choice for longer-term investors.