Lend money, earn interest
Investments that pay interest are often seen as safe investments. But some types of interest-bearing investments may not be as safe as you think. Here we describe different types of investments that pay interest and when they may be right for you.
We also explain the advantages of investing your money with a ‘prudentially regulated’ institution.
How investments paying interest work
What you are really doing is lending money to a company, financial institution or government and in return, you receive interest payments.
Investments that pay interest can differ in the following ways.
- Floating rate – the interest rate can change over the term of the investment, usually in response to changes in the market
- Fixed-rate – the interest rate is set and will not change over the life of the investment
- At call – you can access your money at any time (although some products may require a day or two’s notice)
- Fixed-term – your investment is for a specific length of time
Listed and unlisted investments paying interest
Simple investments like term deposits are unlisted, you invest directly with the financial institution.
Some of the more complex interest-bearing investments such as debentures, unsecured notes and mortgage funds are also unlisted, which usually means you deal directly with the product issuer and they cannot be traded on a secondary market. This may mean they are less transparent and harder to sell.
When interest-bearing investments like bonds or capital notes are listed, they can be traded on an exchange such as the ASX, which makes them easier to value and buy and sell.
Read more on investments that pay interest:
Risks can vary
Just because an investment promises interest doesn’t mean it is safe. Investments vary from the very safe, such as a savings account or term deposit with a major bank, to the very risky, such as unlisted unsecured notes.
You need to examine a product carefully, and not be swayed by the name used to describe the product.
For example, a ‘secured note’ does not signal a safe investment, it means that the issuer has provided some form of security to the trustee of the note issue. The product is not guaranteed, and there is a risk you could lose some or all of your money.
The Australian Government has guaranteed deposits of up to $250,000 in Authorised Deposit-taking Institutions (ADIs) such as your bank, building society or credit union. This is called the Financial Claims Scheme (FCS) and it means your money, up to the stated limits, is guaranteed if anything happens to the ADI. This would apply to products such as savings accounts and term deposits but not to other riskier interest-bearing investments. Find out more about the government guarantee.
Check if the company is regulated
Check whether the company is regulated by the Australian Prudential Regulation Authority (APRA). It won’t guarantee your money, but it does at least mean the company has a higher level of accountability.
APRA regulates banks, building societies, credit unions, life insurance companies and superannuation funds (excluding self-managed super funds).
APRA licenses and monitors the financial soundness of the institutions it regulates, which gives you a higher level of protection than with unregulated entities. It has a list of regulated entities on its website as well as a disqualification register, so you can check that the entity you are dealing with is licensed.
Higher returns, higher risk
Higher returns usually mean there is a higher level of risk involved. You may lose your money if:
- the borrower doesn’t pay you the interest on time
- the borrower can’t pay back your capital when it’s due
When interest-bearing investments are right for you
Different investments paying interest are suitable for different purposes:
- Bank accounts and term deposits – suitable for holding emergency funds, money you are planning to spend in the next few years, proceeds from the sale of an asset that you intend to invest again soon.
- Debentures, secured products and listed investments – you want a secure income stream with interest that’s higher than your bank is paying, or are looking to diversify your portfolio. Products vary in risk considerably so read the prospectus or PDS carefully to understand the security being offered and what your money will be used for.
- Unsecured and unlisted products – you want to diversify your portfolio and are willing to take on more risk in exchange for higher returns. The risk of these products can also vary considerably so make sure you know exactly what your money will be used for, and understand the risks, before you invest.
Not all investments paying interest are suitable for all purposes. Just because an investment is paying interest does not mean that your capital is safe or that you are guaranteed to receive interest payments. You need to understand the nature of the investment and the risks associated with it.
Some types of investments paying interest are relatively safe and others can be quite risky. It’s very important to do your research before you invest in some of these products.
Seek financial advice if you are unsure.