Money: Choices in fixed-interest funds

Even in this corner of the managed fund market, investors are spoiled for choice.

None of these funds is likely to produce spectacular returns; their selling point is relative safety, combined with convenience.

The main contenders are:

Cash management funds: These aim to produce returns slightly higher than you would get for an on-call bank account, by investing in things such as short-term money market securities and bank deposits.

Cash funds are more of a short-term "parking place" rather than a long-term investment - some even offer features such as internet access and chequebooks.

Return over the past year: 3.77 per cent / 5.62 per cent.*

Mortgage funds: These aim to provide returns slightly better than short-term bank deposits, by pooling investors' money then lending it to property buyers.

Return over the past year: 4.17 per cent / 6.22 per cent.*

Fixed-interest funds: Sometimes called "bond funds", these invest in things such as Government and local authority stock, and corporate bonds.

Return over the past year: 3.94 per cent / 5.88 per cent.*

In practice, the lines between the three categories can be somewhat blurred; some "cash" funds also invest in mortgages, for example.

There are also various "conservative" or "capital stable" funds which invest in a variety of low-risk areas.

Adding to the complexity, there is a choice between funds which invest in New Zealand and those which are global.

THINGS WORTH ASKING

How will I be rewarded?

Some funds make regular payouts, in much the same way as interest payments from the bank, which is convenient for investors who need regular income.

With others, any gains result in an increase in the price of units in the fund. To get cash, investors must sell some units.

What about tax?Managed funds can use various legal structures, and that choice has an impact on the way returns are taxed.

Unit trusts pay tax at the company tax rate, 33 per cent, and payouts to investors come with imputation credits attached.

If you are in a lower tax bracket, you can use credits to reduce the tax on your investment earnings to your personal rate.

However, you will have to wait until the end of the tax year to get back the excess tax paid and if you do not have any other taxable income the credits may be useless.

Group investment funds do not provide imputation credits. If you are in the 19.5 per cent tax bracket you can have the correct tax deducted directly, rather than waiting until the end of the tax year.

Insurance bonds pay tax at 33 per cent and do not provide any credits. That is a disadvantage if you are on the 19.5 per cent tax rate, but a slight plus for 39 per cent taxpayers.

What are the fees?

Fees tend to be lower than they are on sharemarket funds, but so are the potential returns.

Before investing, ask about the entry fee, the management fee and whether there is any exit fee. Before going into a fund with an entry fee, be sure you are not likely to want your money out in the near future. If you are not sure, you could be better sticking with a cash fund or a bank deposit.

What about going direct?

Especially for long-term investors, investigate direct fixed-interest investments such as Government stock and corporate bonds, rather than going via a fund.

Among the advantages: minimal fees and a guaranteed return, if you keep the investment through to maturity rather than withdrawing early. It is also easy to see how much risk you are taking, by looking at the credit rating of the investment.

Disadvantages: direct investment is "lumpier"; if you buy Government stock you cannot withdraw a few hundred dollars every now and then.

* Performance figures are the average for locally based unit trusts and group investment funds for the year to June 30, after deducting management fees (but not entry fees). The first number is the return after deducting tax at 33 per cent, the second figure is the pre-tax return. Source: FundSource.