To have a good understanding of interest-bearing investments, learn and know the followings.

The risks of interest-bearing investments, for example:

• inflation,
• interest rate cycles and
• dubious borrowers with poor credit ratings.

The advantages of investing in this asset class, particularly

• the interest income on which you can rely.

Some of the main interest-bearing investments in the market.  These include: 

• cash,
• money market funds,
• bonds,
• participation mortgage bonds and
• voluntary purchased term annuities.

You have to know about two new market places other than the stock market: 

• the money market, where short-term interest-bearing secuities are traded, and
• the bond market, where longer-term interest-bearing securites such as bonds are traded.

A money market fund is a type of unit trust that invests in interest-bearing instruments issued by banks, government and companies when they want to borrow money.

These short-term instruments are

• traded on the money market, and
• have a maturity of less than 12 months.

Money market funds have major advantages in comparison with other cash investments.  For example:

• You gain access to money market instruments even though you invest only a small amount.
• The interest rate is higher than for a bank deposit, as you are part of a group that can bargain for the best wholesale rates.
• You can withdraw your money at any time, like a call deposit at a bank.
• Interest rate risk is largely eliminated because money market funds are allowed to invest only in instruments with an average term of not more than 90 days.

Units in a money market fund have a fixed value of $1, and the only changing aspect is the interest income an investor earns on that unit.

This income is capitalised, or reinvested, which means the investor earns interest on interest.

Money market funds are ideal

• for pensioners who must live on their interest income or
• for the creation of an emergency fund from which you can withdraw money at any time. 

Money market funds also provide useful parking for investors

• to limit the risk of an investment portfolio in uncertain times or
• to phase in their funds.

When you invest in a money market acount, you should know the difference between the nominal and effective rate. 

• The effective rate is the interest rate you will earn if your money is deposited for the whole year and all the interest is reinvested. 
• The nominal rate is lower because this is the rate you earn every month before any reinvestment of interest is taken into account.

Cash has always been seen as a fairly safe investment, and our forefathers were quite happy to put their money under the mattress and leave it there.

Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.

If you want a stable income, a bank deposit is still a valuable investment option.

However, money market funds have become a very popular alternative.

The interest-bearing investments include:

• cash
• bonds
• the money market securities.

Compared to the roller-coaster ride of equities, interest-bearing investments are like a sea of tranquillity.

The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income – often at a fixed rate.

While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.

But this safe asset class is not safe from inflation. 

Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable.  After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.

The reason for this is simple.  Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time. 

In return for this, you earn interest.

Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation. 

Your only real benefit is the income that you receive.

Interest-bearing investments also hold other risks. 

• This asset class is subject to the ups and downs of the interest rate cycle.  As interest rates increase or decrease, your cash flow can be affected – unless you have a fixed interest rate.
• Furthermore, you should beware of institutions with credit risk.  A high interest rate is not everything:  you must also be sure that your capital will be paid back. 

The so-called junk bond market in America is well known as a market where companies with poor credit ratings offer exceptionally high interest rates.  Sometimes it is better to earn less interest, but know that your money is safe.

Interest-bearing investments do, however, play an important part in an investment portfolio.  Although inflation will still erode the capital value of your investment, these investments do have advantages, including:

• offering you a relatively safe and predictable income.
• offering you less risk and volatility than an investment in equities
• offering diversification in your portfolio in case stock markets collapse
• giving you instant access to cash when you need it.