Four alternatives to a term deposit

With interest rates at record lows, the income from a traditional term deposit may be insufficient for some investors who need strong, regular income.

Thankfully, there are a number of alternatives that can potentially fill the income gap, although it is important to remember that none are as safe as a government-guaranteed term deposit.

Below, we look at some of the most popular term deposit alternatives.

RMBS fund

A Residential Mortgage-Backed Security (RMBS) - is a debt-based security that is similar to a bond. It is secured by a pool of residential mortgages over Australian properties. When the property owners make their interest payments on these mortgages, they are pooled and passed through to the RMBS owners.

RMBS bonds are worth many millions of dollars, so they are directly accessible only to institutional investors. An RMBS fund fixes this problem for ordinary investors by pooling their money to buy a portfolio of RMBS bonds. The RMBS fund then distributes income from its portfolio to people who own units in the fund.

While all investments involve some risk, RMBS are generally considered to be a lower risk investment than other popular asset types such as shares.

According to data from ratings agencies, no rated tranche of a prime RMBS has suffered a loss in at least the past 20 years.

RMBS are issued by some of Australia's most prominent banks and non-bank financial institutions. These include Westpac, ANZ, Commonwealth Bank of Australia, National Australia Bank, AMP, Suncorp, Firstmac and more.

If you are interested in investing in RMBS, you can find out more about Firstmac’s High Livez RMBS fund here.

Listed bank hybrids

Hybrid securities are issued by banks and other large corporates to borrow money from investors.

They combine some elements of both debt (bonds) and equity (shares) and they usually trade on the Australian Securities Exchange (ASX).

Hybrids are complicated and their features vary widely depending on the issuer and the terms specified in their Product Disclosure Statement (PDS), so it is important to read the PDS closely.

Bank hybrids are not guaranteed by the Government, so if the bank runs into financial difficulty, you could lose your money or have your hybrids forcibly converted into shares.

Because of their higher risk, listed bank hybrids generally pay more interest than term deposits. However, unlike a term deposit there is no certainty about the timing or the size of the interest payments you will receive.

High-yield ETF

An Exchange Traded Fund (ETF) is a managed fund that trades on the Australian Securities Exchange (ASX).

This means that investing or selling out of the fund is as simple as buying and selling shares on the stock exchange.

ETFs invest in all kind of assets, with some holding balanced portfolios, while others specialise in certain asset classes such as shares, listed property, mining, bonds, small listed stocks and more.

One kind of specialised ETF is the High Yield ETF, which limits its investments to listed stocks with higher forecast dividends relative to other ASX-listed companies. Some high-yield ETFs benchmark themselves against the FTSE Australia High Dividend Yield Index.

By targeting high-yielding companies, these ETFs aim to be able to pass through higher distributions, although their returns are not guaranteed.

Their prices also fluctuate in line with the underlying stocks they own, making them more volatile than many investments including an (RMBS fund).

A-REIT

Directly buying a commercial property like an office tower or a shopping centre is impossible for most Australians but there is another way: the Australian Real Estate Investment Trust (A-REIT).

The way these work is that a professional property investment manager pools together investors’ money to invest in properties, which it then manages. Listed A-REITS typically own multiple properties, and will buy or sell them depending upon their assessment of the property’s value and the needs of the fund. Instead of owning the property directly, investors own units in the fund.

A-REITs earn their income from rents which means they can be a good source of regular income for investors.

You also have the opportunity to receive capital gains (or losses), if the property portfolio changes in value.

Listed A-REITS trade on the ASX, just like any other stocks, which means they are easy to buy and sell but are subject to substantial price fluctuations.