Assessing Fixed Term Investment Risk

Executive Summary

Fixed term investments are frequently grouped together under a general perception of being 'low risk', owing partly to the familiarity of products such as bank term deposits and the presence of the Financial Claims Scheme for eligible deposits. However, this perception can obscure meaningful differences in risk across the broader fixed term category, which spans deposits, government bonds, corporate notes and structured products. This article sets out a general framework for assessing the distinct risk categories that apply to fixed term investments, encouraging a more nuanced approach than treating the category as uniformly low risk.

As with all articles in this series, the framework presented here is educational and general in nature, and does not constitute a risk assessment of any specific product.

Credit Risk: Who Is Actually Obligated to Repay You

Credit risk refers to the possibility that the entity obligated to repay an investment — whether an ADI, a government, or a corporate issuer — fails to meet that obligation in full or on time. This risk sits on a spectrum. Deposits with well-capitalised, APRA-regulated ADIs are generally considered towards the lower end of the credit risk spectrum, particularly given the additional layer of protection offered by the Financial Claims Scheme up to $250,000 per account holder per ADI. Australian Government bonds are also generally regarded as very low credit risk given the sovereign's capacity to meet its obligations. Corporate bonds and notes, by contrast, carry credit risk specific to the issuing company, which can range from investment-grade to sub-investment-grade (sometimes referred to as high-yield), with materially different default probabilities across that range.

• ADI term deposits: relatively lower credit risk, with FCS coverage up to $250,000 per account holder per ADI for eligible deposits.
• Australian Government bonds: very low credit risk given sovereign backing, though subject to market price movements if traded before maturity.
• Investment-grade corporate bonds: moderate credit risk, reflecting the issuing company's financial strength and credit rating, where available.
• Sub-investment-grade or unrated notes: higher credit risk, generally compensated by a higher stated coupon.

Liquidity Risk: Can You Get Your Money Back Early

Liquidity risk relates to an investor's ability to access their capital before the scheduled maturity date, and the cost of doing so. Bank term deposits sometimes allow early withdrawal subject to a reduced interest rate or a notice period, though this is not universal and terms vary by institution. Corporate bonds and notes may or may not have an active secondary market; where a secondary market exists, the price achieved on early sale will reflect prevailing market conditions and may be above or below the original investment amount, introducing an additional layer of uncertainty beyond simple illiquidity.

Inflation and Concentration Risk

Inflation risk, discussed in more detail elsewhere in this series, refers to the possibility that the real, purchasing-power-adjusted return on a fixed term investment is lower than the nominal rate suggests, particularly during periods of elevated inflation. Concentration risk arises where an investor places a disproportionate share of their capital with a single institution or issuer, or in a single term, increasing exposure to any adverse outcome affecting that specific counterparty or point in the interest rate cycle.

A genuinely conservative approach to fixed term investing considers not just the headline rate, but the full combination of credit, liquidity, inflation and concentration exposures involved.

Key Considerations for Investors

• Identify which entity is ultimately responsible for repaying your capital and assess its credit quality accordingly.
• Confirm whether early withdrawal is available, and on what terms, before committing to a term.
• Consider the likely inflation environment over the term relative to the stated rate.
• Diversify across institutions, issuers and terms to manage concentration risk.
• Treat 'fixed term' as a structural description, not a risk rating — assess each product on its specific merits.

Conclusion

Fixed term investments encompass a genuine spectrum of risk, from conservative ADI deposits through to higher-risk corporate notes, and a disciplined investor should assess credit, liquidity, inflation and concentration risk individually rather than relying on the general perception that all fixed term products are inherently low risk. This article is general information only and does not constitute personal financial advice.

Related topics

Information contained within these insights is provided for general information purposes only and does not constitute personal financial advice, an offer or recommendation to acquire or dispose of any financial product. Investors should consider their individual circumstances and obtain appropriate professional advice before making investment decisions.