How to outperform cash
Interest rates have more than doubled over the past three years, making cash a lucrative asset class. However, higher interest led to higher taxes.
How can you earn a higher interest rate and pay less tax?
- A call account at a bank is a basic form of earning interest on cash but low on return. Consider increasing the term and risk of your investment with options like a money market, enhanced interest, flexible income, and bond funds.
- A money market fund extends the average maturity term to 90 days, improving diversification by spreading the exposure among various banks. Earn higher interest through an enhanced money market fund by extending the term to 180 days and adding corporates (credit) to your portfolio. The returns remain stable, but there is a slight increase in risk.
- Flexible income funds invest in various income-generating assets such as cash, nominal bonds, inflation-linked bonds, credit, floating rate notes and offshore instruments. These funds offer higher interest rates but there can be some variability in the capital price.
- Bond funds offer the highest yield as they lend money to governments and corporations over the medium to long term. However, their capital value will be more volatile as the instruments are priced daily according to interest rate movements.
Past performance and fact sheets provide little insight into the risk taken to achieve the higher interest rate. Generally, a higher interest rate can only be generated by taking more risk. Flexible income funds offer a good balance between higher interest rates while managing the risk. These funds also tend to be more tax efficient as the capital component of the return is taxed at a lower rate. Additionally, an endowment structure can be considered to reduce the tax rate. Diversification is always key in managing the risk of an income-generating portfolio. Give yourself an advantage by partnering with the experts!
