Choose your vehicles - options for income-seekers

By Mark Fryer

Watching sharemarkets rise and fall may be exciting, but what many of us want is reliable income rather than capital gain - either because we're at the age where we have to live on our investments, or as part of a larger portfolio. The choices for income-seekers go much further than the ever-popular bank term deposits, to things like government stock, corporate bonds or property syndicates.

They may be less stimulating - or nerve-wracking - than some other investments, but boring isn't necessarily the same thing as secure.

And security is especially important here; you may be happy to take a calculated risk on the sharemarket, for example, but losing money that you rely on for income is much harder to accept. The risks may not be obvious, and while some larger institutions can point to their credit rating as proof of their security, many will not.

The simplest guide is to remember the old connection between risk and return - the higher the return, the more risk you're running to get it.

Treat terms such as "secured" or "first-ranking" with a degree of cynicism - they tell you how far up the pecking order you'll be if the firm you invest with goes bust, but they don't tell you anything about the company's financial strength.

Term deposits

Available from banks and some other institutions, these are the best-known fixed-interest investment of all and very, very popular - we have more than $30 billion in them.

Rates vary depending on how much you're investing and for how long. At present the best rates - 6.25-6.50 per cent - are being offered for longer-term deposits, typically five years. For the latest rates, check the table published every weekend on the back page of the Herald's Weekend Business section.

If you stick with the big institutions, the risk of not getting your money back is next to non-existent. The main risks are that inflation might rise, eating into your real returns, or that interest rates could go up and you could miss out on the rise because your money is locked up.

There's not much you can do about either of those eventualities, but you can smooth out the ups and downs by splitting your term deposits so they aren't all due for renewal at the same time.

Cash Management Trusts

These are a type of managed fund in which a manager pools money from lots of investors then lends it out on the short-term money market.

Because rates fluctuate constantly - often by the day - these are not a substitute for term deposits, where your return is locked in.

However cash management trusts may be an attractive alternative to "on call" deposits such as savings accounts. Exact terms differ, but some trusts can be very flexible, allowing you to easily transfer money between the trust and a bank account, for example.

Best used as a "parking place" for money you don't want to lock away for a set term.

Debentures

Usually issued by finance companies, which raise money from the public then lend it out to businesses.

A wide range of terms is available, with rates that are typically higher those offered by term deposits (over 8 per cent in some cases).

Finance companies range from the small (which are most likely to offer the higher rates) up to some very large companies, some owned by banks. Debentures can be difficult to get out of early, and you may face a penalty for doing so. Check before you invest.

Kiwi Bonds

Even safer than houses, given that they are provided by the Reserve Bank.

These behave very much like a standard term deposit, with the interest rate and the term set at the time you invest.

Minimum investment is $1000 and the return depends on the term and the amount - currently it ranges from 3.5 per cent for $1000-$4999 invested for six months, up to 5 per cent for $5000-plus for four years. Interest is either paid out quarterly or compounds quarterly and is paid at the end of the term. Available direct from the Reserve Bank (0800-655-494).

Government Stock

This is the Government's way of raising cash, by borrowing it from investors, including some of our biggest institutions.

Smaller investors - those with $10,000 or so - can also put money into government stock, through a sharebroker or investment adviser.

Like Kiwi Bonds, this is also super-secure, though the way it works is a little more complex than many other fixed-interest investments.

Instead of putting in a fixed amount and getting a fixed interest rate, you buy stock which has a "face value" of, say, $10,000, but which may cost you more or less than that. What you get for your money is a promise that the Government will repay the $10,000 when the term is up, and pay interest along the way.

Depending what direction interest rates are going in, you may pay more or less than $10,000 - buying at a "premium" or a "discount" as they say. Your total return comes from the interest payments, plus or minus the premium or discount.

If this seems complicated there's no need to fear, the people who sell Government Stock have wrapped all the maths into one figure, the "yield" which tells you what percentage return you're getting on your investment. Government Stock is available for a variety of periods, running right out to the year 2016.

Rates can change by the minute but at present yields range from 4.28 per cent a year, for stock maturing next February, to over 6.3 per cent for stock maturing in 2011.

Because of the way Government Stock is traded, you'll always be able to sell to someone else if you want to get out before the maturity date. Whether you make a profit or a loss depends on the direction in which rates are moving (you win if they fall, and lose if they rise).

However if you hold your stock until maturity you will get the promised yield.

As well as run of the mill Government Stock, inflation-indexed stock is also available. It effectively pays a return of 4.5 per cent on top of the current inflation rate.

Corporate Bonds Sometimes called "capital notes" or just "notes", which are effectively the same thing.

These investments trade in the same way as Government Stock and are issued by companies, state-owned enterprises and local authorities.

The minimum investment is often $5000-$10,000, though it can be much higher for local authority stock - anything up to $25,000-$50,000.

Like Government Stock, these investments can be sold before maturity if you want to get your money out, with the chance of making a gain or a loss if you do.

Bonds issued by a very strong organisation may be rated almost as highly as Government Stock, and may offer only a slightly higher return. Transpower's bonds, for example, are currently yielding between 5.29 per cent for investments maturing in February 2001, up to just over 7 per cent for December 2010 bonds.

Further down the corporate tree, Brierley Finance capital notes are yielding over 9 per cent.

Higher returns mean higher risk; the security of these investments ultimately depends on the financial strength of the company or organisation that issues them.

Managed funds

There are a variety of funds which aim to produce income, including mortgage trusts, bond funds and some property funds. Returns are typically not guaranteed, but will change in line with interest rates generally.

Before investing in such a fund, be sure you understand the tax situation, and try to keep the fees as low as possible.

Remember that it is possible for some of these investments - bond funds, for example - to make a capital loss even though their underlying investments are very secure, if they actively trade those investments.

Property syndicates

Enormously popular at present, and no wonder given the interest rates they are offering - typically in the 9-10 per cent range.

Syndicates usually own a relatively small number of buildings, sometimes just one, and pass the returns on to investors.

One advantage is the fact that they allow relatively small investors to put money into commercial and industrial buildings they could never afford on their own.

And if you like the idea of knowing exactly where your money is going, the relatively small size of most syndicates may be a benefit. You can even drive past "your" building and feel that warm glow of ownership.

But because your money is tied up in such a small number of properties, the security of your return depends heavily on the quality of those properties.

Buildings where a tenant is about to depart, where the current rent is much higher than the going rate, or where major maintenance is overdue, could bring investors a nasty surprise.

The important thing is to be sure you are buying a stake in quality property, with well-established managers.

One drawback is that, if you want to get your money out, it may not be easy to break your investment. Some syndicate managers have set up a market in their investments, but it doesn't compare to the well-established market in things such as government stock or corporate bonds.