It’s widely expected that the RBA will deliver at least one more rate decrease this year. Combine this with a volatile stock market and the humble Term Deposit is something to be revisited. Sure, it’s about as exciting as cold porridge BUT it does offer a guaranteed rate of return. Anthony Fensom is here to offer a little more detail on Term Deposits.
Term deposits can provide higher interest rates than regular transaction accounts. However, not all term deposits were created equal and there are traps to look out for before locking away your money.
Weighing up the pros and cons
Term deposits are covered by the government deposit guarantee, which guarantees deposits of up to $250,000 per depositor per institution – giving peace of mind that your money is secure. Terms can vary from as short as a month to five years or more, while the interest paid is higher than that offered for normal transaction accounts.
Unlike other investments such as shares or managed funds, term deposits provide certainty concerning the expected return, benefitting those requiring less risk. The interest rate is fixed for the duration, with all capital repaid at the end of the term.
However, on the downside is the fact that your money is locked away for the term’s duration and cannot be readily accessed. Penalties often apply for early withdrawals, and it may be possible to earn similarly high rates with more flexible online savings accounts.
How to maximise returns
Before the term deposit matures, it’s advisable to shop around to make sure you are still receiving a high rate. Some lenders automatically roll over the funds on maturity into a new term deposit, sometimes at a lower rate.
Depositors should also check the effective rate as it accounts for the frequency of interest payments, with those paying more often having a greater value.
1. Climbing the ladder
There are a number of strategies to maximise the benefits of term deposits such as “laddering”, which involves splitting your funds into deposits with different maturity dates.
For example, a lump sum of $50,000 could be split into three term deposits comprising $20,000 in a three-year term, $20,000 in a two-year term and the remaining $10,000 in a one-year term. As each term deposit matures, the saver invests the funds into a new three-year deposit, thereby benefitting from the higher interest rates available from longer terms without locking all the money away into a single term and rate.
2. Firing bullets
Another strategy known as “bullets” would involve investing part of the $50,000 into a five-year term deposit and the remainder into a high interest savings account, such as those provided by RaboDirect.
Each month the saver chooses the best term deposit to invest a further portion of the $50,000, continuing the process until the full amount is invested in term deposits but ensuring each one matures around the same time as the first term deposit.
Another strategy involves “blending” term deposits with other investments to boost returns. Rather than holding all investments in cash, conservative investors might instead allocate 90 per cent of their funds to term deposits and the remainder to riskier assets such as shares.
Profits from the share investments, such as dividends or capital gains, should be reinvested into term deposits, thereby giving growth exposure at lower risk.
With the increasing volatility of financial markets, the security and comparatively high interest rates that come with term deposit accounts make them an attractive inclusion in the avid investor’s portfolio.[Sources]