QMy wife (65 this year and retired) and I (61 next year and still working) are among a group of fortunate people who are debt-free, have a freehold home, an investment property (also freehold) and an ability to continue to accumulate spare cash.
We have always had a very conservative approach to financial matters and although we did dabble with WiNZ, TENZ and BIL (and similar) some years ago, and did exit these with a profit, we think that share market investments carry too much risk for us.
Consequently, we find ourselves with bank term deposits of around $35,000 and an investment with Fisher and Paykel Finance (Secured 1st Ranking Debenture Stock) of $60,000.
F & P Finance pay a higher rate of interest (presumably reflecting a higher risk) than our bank term deposits, but we feel that given the pedigree of the company and the areas in which they say they apply the funds, the actual risk is probably only a little greater than that of bank term deposits.
Despite this optimism, we find ourselves reluctant to increase our exposure to F & P.
Our question is: How, from the multitude of fixed interest offerings, do we determine which have a risk profile that is similar to our perception of that of F & P Finance?
We are hoping that you will consider a column that discusses the differing risks associated with bank term deposits, secured 1st ranking debenture stock, secured debenture stock, debentures and some of the other financial instruments that might have appeal to people in our position.
Also, and I suspect that this is the most relevant question, how do simple souls such as ourselves determine the quality of the companies who are making the offers?
ABy looking at their credit ratings.
Go to www.interest.co.nz, and check out “Term deposits less than 1 yr”, “Term deposits 1–5 yrs”, and “Money Market”.
The two term deposit sections include deposits, debentures and the like issued by banks, building societies, credit unions, finance companies and the Reserve Bank.
Under Money Market are fixed interest investments that are traded on the stock exchange’s debt securities market — which means you can buy and sell them pretty much when it suits. They include government stock and securities from SOEs, local authorities and corporates.
Alongside their names, many of the institutions in all three sections have credit ratings that look like:
- AA- or BBB+ or similar, rated by Standard & Poor’s (S&P). AAA is best.
- Aa3 or Baa3 or similar, rated by Moody’s. Aaa is best.
- G2 or G7 or similar, rated by Grosvenor Financial Services’ BondWatch. G1 is best.
S&P and Moody’s are international ratings services, which do considerable research on each company before giving it a rating and then monitor companies and re-rate when necessary.
BondWatch is a New Zealand service. The company uses only information in prospectuses and investment statements, so the ratings are not as comprehensive.
You shouldn’t, therefore, feel quite as confident in a high BondWatch rating as in a high S&P or Moody’s rating.
Still, the BondWatch ratings do give you some guidance. Given that you want to avoid taking too much risk, I would certainly steer clear of products with BondWatch ratings of G7 or G8.
Your Fisher & Paykel Finance debentures actually have a G5 rating, which is not all that strong.
G5, says BondWatch, means, “Adequate ability to meet current obligations, but uncertainty about levels of security over the longer term, particularly under adverse business conditions.”
So I would avoid putting more money in that direction — a good idea anyway, even if the rating were stronger, just to keep your eggs in several different baskets.
I suggest that you spend a bit of time on www.interest.co.nz, including reading its Consumer Guide. For more on BondWatch, type in www.bondwatch.co.nz. (The actual name of the website is more complicated, but that will get you to it.)
Note that the websites take no responsibility for incorrect ratings, so you should check elsewhere before investing.
Then I suggest you talk to a sharebroker. They handle fixed interest investments as well as shares, and can help you to select the most appropriate ones. Highly rated corporate bonds might be your best bet.
A few more points:
- Some institutions have no rating. That doesn’t necessarily mean trouble, but the unrated companies tend to be smaller. Given your conservatism, you might want to stick with the rated ones.
- Even a high rating is no absolute guarantee against default — although government stock and the Reserve Bank’s Kiwi Bonds, with their AAA ratings, are rock solid.
- Occasionally an institution will have more than one rating. For example, its debentures might have a higher rating than its subordinated notes.
QIf I buy a government bond with a face value of say $1000 and coupon rate of say 8 per cent, but yielding say 6 per cent, I’ll pay tax on $80 each year won’t I, even though the yield is less than that?
Will there be an offsetting capital loss on maturity?
AThe minimum government bond purchase is actually $10,000, but the principle is the same, so we’ll stick with your example.
Let’s first explain the situation to others.
When the bond was first issued, it cost $1000. Throughout its life it will pay $80 in interest each year, and the holder at the end will get $1000 back. In the meantime, the bond can be traded.
If interest rates have fallen since the issue date to around 6 per cent, everyone will want to buy an 8-per-cent bond. This demand will push the price up higher than $1000 to, say, $1050.
If you’re a buyer at that point, it looks like a bad deal. You pay $1050 and you’ll get back only $1000 at maturity. What’s more, you’ll receive $80 interest on your $1050 investment, which is not 8 per cent but 7.6 per cent.
Taking those two factors into account, you’ll actually receive an over-all yield of 6 per cent. But, given that that is the current market rate, you have to accept that.
What about taxes?
You’ll receive $80 interest a year, so that’s what you’ll pay tax on.
You will, however, be able to deduct the capital loss, says PricewaterhouseCoopers tax partner Tony Gault.
While most people who own shares for the long term can’t deduct capital losses and don’t pay tax on capital gains, the situation is different for government bonds, which come under what are called “the accrual rules”.
Everyone can deduct a loss on a government bond, either at maturity or when they sell it, says Gault.
On the other hand, anyone who makes a gain — which happens in the opposite scenario, when interest rates rise — has to pay tax on that gain.
Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.