KEY POINTS:
In the olden days, when people retired they picked up their gold watch, cashed in their superannuation savings and invested the proceeds almost entirely in fixed-interest investments - i.e. bonds.
As an investment strategy, investing everything in fixed interest might have worked reasonably well - life expectancy was shorter, inflation was low and bonds gave certain income.
However, having everything in bonds won't work now.
First, because we have longer life expectancy and second, because the spectre of inflation is always with us - our money has to last longer and work harder.
It is important to recognise that fixed-interest investments carry risk. At a time when many people have seen their investment returns hammered by the demise of the finance companies, collapsing share and property prices and bank deposit rates sinking to almost nothing, investors are bound to be anxious.
It may seem that the cavalry has just appeared over the horizon in the form of a whole bunch of new bond issues: Fonterra, Tower, New Zealand Post, Auckland City Council - you can almost hear the collective sigh of relief from investors who have been wondering what to do.
Not so fast. These bonds are welcome - I have suggested some of them to many of my clients - but they are not without risk and they should certainly not be the only thing that in which you invest.
The big risk to bonds is the obvious one that the borrower will not pay interest or give you your money back at the end of the term. But there is another risk: inflation.
If you take out a $20,000 bond for six years with a good issuer, you are very likely to receive regular interest payments and in 2015 you will get your $20,000 back.
Your problem is that when you get your $20,000 back, it is not the same $20,000 it was at the start. Even at 2 per cent, inflation has attacked it and the spending power of your capital is now less than $18,000.
It could get much worse - the world is in a terrible recession and, in response, governments are cranking up the money-printing presses. There is a risk that we get hyper-inflation. If that happens, these bonds will look very sick.
Inflation at 10 per cent would mean that, in 2015, your original $20,000 will only have the spending power of $10,600. And, of course, the interest you receive will also have deflated each year over the term of the bond.
I know the world is a scary place at present and these bonds being offered seem the perfect safe haven.
But they are not.
The risks are not as obvious as crashing share markets or burning finance companies. Inflation is much more insidious, but no less real.
Put some of your money into fixed-interest investments - but not all of it.
The noise that you hear may not be the sound of the cavalry to the rescue, but the hum of the money-printing press.
Each week financial author Martin Hawes shares strategies to help you grow your wealth. You can email finance questions to info@wealthcoaches.net or andrea.milner@heraldonsunday.co.nz
