Investing basics: Is it better to invest in stocks, government bonds, or term deposits?

It seems like every investment guru won’t stop mentioning how important it is to not put all your eggs in the same basket; i.e. to diversify your investment portfolio. But as an investor, where is the best place to put your money?

Is medium to long-term investments better in the current period of economic uncertainty in pursuit of stability and potentially modest returns? Or is it better to find a short-term investment that provides more liquidity to your assets?

Here we have compiled the three most common investment products with various degrees of characteristics, goals, risks, and time horizons which should help you gain a deeper understanding of which product is the most suitable for you.

Stocks

A stock represents fractional ownership of equity in a company. Here are some considerations when investing in stocks:

(1) Potential for growth

Stocks offer the potential for capital appreciation and dividend income. Historically, stocks have delivered higher average returns in the long term compared to other asset classes like bonds or cash. Over extended periods, well-diversified stock portfolios have shown the potential to outperform inflation and generate substantial growth. While short-term volatility can occur, focusing on the long-term trends and staying invested through market cycles can potentially yield significant growth.

Stock market growth can be influenced by economic factors like the rate of economic expansion (GDP growth), prevailing interest rates, inflation levels, and the financial performance of companies (corporate earnings). Favourable economic conditions and positive market sentiment can contribute to stock market growth.

The return from shares may comprise a growing income stream (dividends) as well as capital growth.

(2) Diversification

Investing in stocks across various industries and companies helps to spread risk across different assets, sectors, or regions, ultimately reducing the impact of poor performance in one investment by potentially benefiting from the positive performance of others. Investment in a variety of assets lowers the risk associated with any single investment.

Within each asset class, diversification can be achieved by investing in different sectors or industries. Different sectors perform differently depending on market cycles and economic conditions. Spreading investments across sectors reduces the risk of being heavily exposed to the performance volatility of a single sector.

Investors can also diversify investment in companies of different sizes (large-cap, mid-cap, small-cap) and types (growth, value). Each category has its own risk and return characteristics, but diversifying across company sizes and types reduces concentration risk in a particular segment of the market.

(3) Liquidity

Stocks are generally considered highly liquid investments. They can be easily bought or sold on stock exchanges, offering investors the ability to convert their shares into cash quickly. The high liquidity of stocks allows investors to respond promptly to market conditions, take advantage of investment opportunities, or access their funds when needed.

(4) Risk and volatility

Though it comes with higher average returns, stock investment also comes with higher volatility and risk, even considered riskier than government bonds or term deposits.

Market volatility can lead to significant short-term price swings. Economic factors, such as recessions, inflation, interest rates, and geopolitical events, as well as business risks such as competition, regulatory changes, or poor management decisions, can also heavily impact stock price fluctuations.

Loss of Capital: When investing in stocks, there is a risk of losing part or all of the invested capital. Stock prices can decline, and if an investor sells at a lower price than the initial investment, they may experience a loss.

How to buy stocks in Australia?

The most common way to buy and sell shares is by using an online broking service or a full service broker.

There are dozens of platforms available to Australian investors – some of them are offered by the Big Four and other major banks, while others are provided by specialist share brokers.

Click here to find out more of brokerage types in Australia. It is important to compare the features and brokerage fees from various platforms before choosing the right one for you.

Meanwhile, both government bonds and term deposits fall under the category of fixed incomes.

Government bonds

A government bond is a type of debt security issued by a national government or government agency to raise funds from investors. Investors are essentially lending money to the government when they purchase a government bond. In return, the government promises to make regular interest payments, known as coupon payments, to the bondholder for the duration of the bond’s term. At the bond’s maturity, the government repays the principal amount, known as the face value or par value, to the bondholder.

Some things to consider when investing in government bonds:

(1) Security and low risk 

Depending on the issuer, bonds can provide greater certainty that principal will be repaid at maturity than other investment products. Moreover, government bonds are typically considered low-risk investments as they are backed by the government’s ability to tax and print money, making them less likely to default compared to other types of bonds or investment products. They are widely used by governments to finance public projects, manage budget deficits, and fund government operations.

(2) Greater certainty

The standard Australian government bond (AGB) guarantees a rate of return on the bond’s value when held to maturity, therefore holds greater certainty for investors who need a fixed income stream such as retirees.

(3) Long time horizon and lower returns
Investing in bonds often requires committing money for a significant duration, ranging from five to over 20 years, as most bonds have long maturity periods. Investors may need to hold the investment for an extended period without easy access to the funds.

Moreover, government bonds tend to offer lower potential returns compared to riskier assets such as stocks or corporate bonds. The trade-off for their lower risk is a relatively modest yield, which may not keep pace with inflation or provide substantial capital appreciation.

(4) Interest rate and inflation risk
Government bond prices are affected by changes in interest rates. Rising rates generally lead to lower bond prices, resulting in potential capital losses if sold before maturity. Conversely, falling rates can boost bond prices, potentially leading to capital gains. Longer-term bonds also face inflation risk, as rising prices erode the real value of future interest payments and principal. Failure to keep up with inflation can reduce the bond’s actual return.

How to buy Australian Government Bonds?

Government bonds are transacted only through licensed ASX brokers. Investors must have a CHESS account along with access to financial institutions that provide access to bond markets. This allows you to place orders and execute transactions.

Government bonds can be bought on these occasions, among others:

(1) Government bond auctions

The Australian government conducts bond auctions periodically, where investors can directly participate in purchasing government bonds. These auctions are typically open to both institutional and retail investors. Information about upcoming auctions, bond terms, and bidding processes can be found on the Australian Office of Financial Management (AOFM) website.

(2) Primary market offerings:

Government bonds may also be available through primary market offerings facilitated by financial institutions. These offerings provide an opportunity to purchase newly issued government bonds directly from the issuer or authorized intermediaries. Financial institutions, such as banks or brokerage firms, can assist in accessing primary market offerings.

(3) Exchange-Traded Funds (ETFs) and Managed Funds

Investors can also consider investing in government bond-focused ETFs or managed funds. These investment options pool money from multiple investors to create diversified portfolios of government bonds. Government bond-focused ETFs are traded on the ASX, while managed funds can be accessed through fund managers or online platforms. ETFs track specific types of bonds, such as government bonds or high-yield bonds, offering investors exposure to a specific bond market segment.

The minimum investment holding of any Government bond (both Treasury and Index Treasury bonds) is one unit which is equivalent to $100 face value of the bond over which it has been issued.

Term deposits

A term deposit, also known as a fixed deposit or certificate of deposit (CD), is a type of savings account offered by banks and financial institutions. It is a low-risk investment option where you deposit a specific amount of money for a predetermined period, known as the “term” or “tenure.” During this period, the funds are held by the bank, and you earn a fixed interest rate on your deposit.

Some things to consider when opening a term deposit:

(1) Fixed term and interest rate
Term deposits have a fixed duration, typically ranging from a few months to several years. The specific term is agreed upon at the time of opening the deposit, which ultimately offers predictable returns and are considered low-risk investments. Moreover, unlike other investments tied to market performance, term deposits offer a guaranteed return of the principal amount plus interest at the end of the term. This allows you to know in advance how much interest you will earn.

(2) Low risk

Term deposits are commonly used for short- to medium-term savings goals or as a part of a diversified investment portfolio. They are considered low-risk investments because they are typically insured by government deposit insurance schemes, protecting customer deposits up to a certain amount in the event of bank failure.

(3) Interest payment options
Interest can be paid out periodically (e.g., monthly, quarterly) or at the end of the term, depending on the deposit agreement.

(4) No early withdrawal

In most cases, term deposits do not allow early withdrawal of funds before the maturity date without incurring penalties or forfeiting some or all of the accrued interest. Therefore, term deposits are suitable for individuals who prioritise capital preservation, and most importantly do not need immediate access to their funds.

(5) Lower returns
A term deposit functions like a high-interest savings account, in which we can put money into it and will achieve higher returns than a regular bank account. However term deposit interest rates are generally lower than potential returns from stocks. The returns may not keep pace with inflation, which can erode the purchasing power of the investment over time.

How to open a term deposit account in Australia?
Opening a term deposit account is considered simpler, as most banks and financial institutions offer term deposit accounts. This can be done by reaching out to the chosen financial institution to inquire about their term deposit offerings and to initiate the account opening process. It is important to consider factors such as interest rates, terms and conditions, fees, and the institution’s reputation and stability.

To make investment choices between stocks, government bonds, and term deposits, consider your investment goals, risk tolerance, and time horizon. Diversifying your portfolio across different asset classes is recommended to balance risk and potential returns. Seek guidance from a financial advisor to align your strategy with your specific circumstances.