Interest money

How rising interest rates can benefit your portfolio

Following the Reserve Bank of Australia’s decision to raise the cash rate for the seventh consecutive month, major banks and other deposit takers raised interest rates on their savings accounts and term deposits as that they were looking to expand their deposit books. At the same time, other fixed income investments also pay more as income options multiply.

For savers who depend on cash and term deposits for income, rising interest rates are good news. According to data from the Reserve Bank of Australia, the average rate on banks’ bonus savings accounts rose from 2.25% in September to 2.55% annually, and jumped a meager 0.25% per year a year earlier.

Average interest rates on one-year term deposits offered by major banks jumped to 2.7% pa in October, from 1.5% pa in September, while the average interest rate on three-year term deposits practically doubled, rising from 1.65% to 3.2% per annum in October. not in September 2022.

What some savers may not know is that there are more fixed income investment options available to savers than just online savings accounts or term deposits. Some bond investments also pay more now that interest rates are rising and pay more than term deposits or savings accounts.

Fixed income ETFs that could benefit from rising rates

For income-seeking investors who are willing to take a little more risk than those involved in depositing cash, some exchange-traded funds (ETFs) offer exposure to bonds with a variable interest rate coupon that increases with interest rates.

These bonds are known as floating rate notes (FRNs); since their coupon is variable and increases with market interest rates, the value of the bond is not as sensitive to rising interest rates as fixed-rate bonds, such as bonds ‘State.

Thus, while the price of fixed rate bonds generally declines when rates rise, FRNs offer greater stability of capital in a rising rate environment than government bonds.

So while many bond funds are down around 12% or more this year, the Solactive Australian Bank Senior Floating Rate Bond Index is up 0.09% YOY to October 2022.

Importantly, FRNs aim to provide rising income in a rising rate environment. This means that the return earned on FRNs has the potential to increase over the next 12 months, whereas the interest rate on a 12 month term deposit is currently fixed. The same is true for a three-year term deposit.

An ETF that invests in FRNs has other advantages over term deposits.

ETFs are more liquid because investors can buy or sell an ETF on the ASX with T+2 liquidity, or within three days, which means they don’t need to lock in their money for several months or years. Also, if you’ve locked in your money for a year or more, you won’t get any benefit if rates go up. On the other hand, the yield of FRNs generally benefits from any future rise in rates.

In the past, it was difficult for retail investors to buy FRNs, which are a type of corporate bond. But ETFs have allowed investors to hold a portfolio of FRNs, which can bolster the defensive side of their portfolio when interest rates rise and equity markets are expected to remain volatile.

The BetaShares Australian Bank Senior Floating Rate Bond ETF (ASX: QPON) invests in senior FRNs issued by Australian banks, which are among the most liquid and highest rated corporate bonds issued in Australia. QPON is currently offering an aggregate return of 4.08% per annum (as of November 16, 2022) and market pricing suggests that the aggregate return will continue to increase to nearly 5% per annum in six months.

If, however, you are a conservative investor and do not want to take more risk than cash investments, interest rates on cash savings accounts are at their highest for several years. The BetaShares Australian High Interest Cash ETF (ASX: AAA) invests in cash deposit accounts held with certain banks in Australia.

As of November 16, 2022, the interest rate charged on AAA deposits was 2.97% per annum, after fund management fees and costs, a significant increase over interest rates on deposit accounts. savings from many banks. Additionally, AAA pays a monthly income and has the added benefit of being exchange-traded, so investors have greater flexibility to deploy their capital if a buying opportunity arises.

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