From time to time I like to use the medium of our website to improve the knowledge of our clients and website readers. My topic for this month is ‘fixed interest’ investment.
When constructing a portfolio for a new client, I will explain the spread of investments and frequently say, ‘and we have allocated x% to fixed interest to bring down risk, or to balance the risk in the portfolio’. The client will nod sagely. I have no idea if they understand what I have just said. Therefore, for those still on a learning path on the subject of investment, I will briefly explain a fixed interest security and its place in a portfolio.
We all understand a loan. If, for example, your son was about to put down a deposit on a new flat and was £20,000 short, you may say that you would lend him this money. If you were attempting to teach your son how such an agreement would operate commercially, you should, although I doubt you would, get a loan agreement set up. It would say that you would lend him the money over a period of six years, that he would pay you x% interest monthly, and that he would repay the capital in six years’ time. This is a fixed interest investment.
Instead of making the loan to your son, you could lend your money to the UK or an overseas government, or to a quoted, unquoted or private company, or you could purchase units in a collective fund. Some collective funds will invest only in fixed interest stock, and others, such as a managed or mixed fund, will hold a percentage of the fund in fixed interest securities.
No investment is risk-free. The risk in lending your money to a business or government is that the loan will not be repaid, or that the borrower will default on the interest payments. Purchasing loan stock such as gilts in the UK, or Treasuries in the USA, is very low risk, and the risk of default is low. However, lending to countries in the developing world, rather than the developed world, carries a higher risk. Rating agencies will grade the bonds, and the low-risk client will wish to avoid what is known as junk bonds. Junk bonds can be easily recognised because the interest rate offered on the loan is always high.