Where to put your money in a low-interest rate environment
Global central banks have been cutting interest rates to help economies recover from the COVID-19 pandemic.
In November, the Bangko Sentral ng Pilipinas cut benchmark rates by another 25 basis points, bringing the cumulative rate cuts to 200 basis points this year. It also cut the banks’ reserve requirement ratio by 200 basis points in March.
These, coupled with weak demand for loans, had pulled down interest rates on bank deposits to record lows. The yield on time deposits is less than 1 percent from 2 to 4 percent the past few years. This is forcing even the most conservative investors to consider investing in riskier higher yielding instruments.
The good news is, there are many alternative investment products that can yield higher returns. Here are some of the alternative products that are available to retail investors:
Government bonds
Government bonds are the least risky products. In a worst-case scenario, the government can print more money to meet its obligations.
Investors can subscribe to Premyo Bonds. Available up to Dec. 11, Premyo Bonds are one-year bonds that yield 1.25 percent and offer a chance for investors to win up to P6 million or a brand-new car in a raffle draw. The product is affordable as the minimum investment is only P500. Normally, investors would need millions to buy government bonds.
Investors can buy longer-term government bonds through banks to earn higher yields. That said though, yields are still very low. Current yield on the government’s five-year bond is only 2.6 percent while that on the 10-year bond is only 2.9 percent. While yields on longer term bonds are higher, the market value of longer-term bonds is more sensitive to interest rate fluctuations. If interest rates go up, the market value of a 10-year bond will go down more sharply than a 5-year bond. If you expect interest rates to go up soon, it is better to buy shorter-term bonds. Corporate bonds
Investors who are willing to take on more risk can generate higher returns by investing in corporate bonds. Yields on corporate bonds are higher compared to government bonds because corporations face a greater risk of default. Yields on corporate bonds are also varied, depending on the credit worthiness of the company issuing the bonds and the term of the bond issue. Yields on longer-term bonds and bonds issued by riskier companies are higher than those on shorter-term bonds and bonds issued by credit-worthy firms.
Like government bonds, investors need millions of pesos to avail themselves of corporate bonds, making it out of reach of retail investors. The market value of corporate bonds is also inversely related to interest rate movements.
Preferred shares
Preferred shares provide higher yields compared to corporate bonds. The market value of preferred shares is sensitive to interest rate fluctuations. But they are more affordable and can be bought for a few thousand pesos. Taxes on preferred share dividends are also lower at 10 percent compared to the 20 percent on interest income from bank deposits and bonds.
Preferred shares are riskier than bonds. If the issuing company goes bankrupt, bond holders get paid ahead of preferred shareholders. So buy only preferred shares issued by firms you believe will stay solvent.
Real estate investment trust
REITs provide higher yields than bonds. They are affordable and taxes on dividends are lower at 10 percent. REITs are riskier as the amount of dividends it pays is dependent on the income it can generate from its income generating portfolio. High-yielding stocks
Investors looking for even higher yields can buy stocks with high dividend yields. Because the market is depressed, many companies trading in the Philippine Stock Exchange provide dividend yields that are higher than bank deposit rates. Since valuations of most stocks are cheap, investors who are willing to hold on to these high dividend yielding stocks for the long-term can benefit from capital appreciation. However, prices of stocks tend to be more volatile in the short-term. Investors who buy stocks with high dividend yield should be ready to hold on to their stocks for a long time. Moreover, when buying stocks for cash dividends, it is important to look for firms whose profits are still expected to grow in the future. This increases the probability that cash dividends will rise and the stock’s market value will go up.
Choosing a suitable alternative investment can be daunting given the risk return profiles of various investment options. But staying in cash is also risky. History has shown that low interest rates lead to higher asset prices.
Although staying in cash will ensure the preservation of its value, the amount of cash you have today will not buy you the same amount or quality of assets in the future. INQ
