Term Deposits vs Preference Shares

By Jason Fittler

How to achieve the best return for your money.

Term deposits are great investments in time of high uncertainty or high interest rates, BUT when interest rates fall so does your income and capital. In a period of falling interest rates and high inflation, which is happening right now, term deposits are not the right tools to be using.

Example: $100,000 invested now at a rate of 4.2% will return $4200 for the year. Inflation is running at 3.7% which means you now need $103,700 to purchase the same amount of goods as $100,000 did last year. You will also have to pay tax, even at 20% this would cost you $840. Your net return from the term deposit is -$340.

This is ok if you are looking for security, but if you need this income to live off it is a different story.

Preference shares are higher ranking stock than ordinary shares, and its terms are negotiated between the corporation and the investor.

  • Preferred stock usually carries no voting rights, but may carry superior priority over ordinary shares in the payment of dividends and upon liquidation.
  • Preferred stock may carry a dividend that is paid out prior to any dividends to common stock holders. Preferred stock may have a convertibility feature into common stock.
  • Preferred stockholders will be paid out in assets before common stockholders and after debt holders in bankruptcy.

Benefits of Preference Shares

1. They pay an interest return at a premium to the bank bill rate; this premium will range between 1.5% and 4%.
2. They have a face value, at expiry you get back your initial invest or more if you buy them at a discount.

Risks

1. The underlying company stops paying income.
2. The underlying company goes broke.

For a little more risk you are able to achieve a much better return, we normally focus on buying preference shares in well know blue chip companies.... Such as CBA, Westpac, Macquarie Group, ANZ, BOQ and Woolworths. This reduces the risk of loss.

But the real kicker is at present, Preference shares are trading below face value, this is due to investors being scared and taking their fund and placing it in term deposits. This means you have an opportunity to get a great yield and some capital growth. The average yield to maturity is around 9%.

Summary; if you do not think that the above companies are going broke and you want a better return then 4%, for a little more risk then give us a call today and we will let you know when preference shares best suit you. Ph: 07 4771 4577