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The pitfalls and the positives of auto-rolling term deposits

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If you are a fan of term deposits (TDs) with their guaranteed rates and fixed terms, you may well be choosing to, either consciously or unconsciously, ‘auto-roll’ (re-invest) your investment when it matures. This means that when you took out a TD investment, you agreed to let your bank (or other TD provider) reinvest that money into another investment of the same term if you don’t notify them to the contrary before maturity.

But make no mistake the TD provider certainly didn’t say the auto-rolled deposit would be at the same rate of interest. With auto-rolling of TDs the rate that is applied to the new investment is the going rate for that term at maturity of the previous deposit. And depending on what’s been happening with interest rates it could be the auto-roll rate is significantly less than what you got the first time around.

There is nothing illegal here – the TD provider is simply following the only instructions it has from you ”“ even if you are silent on it. While they’re simply taking care of the reinvestment for you – which some might see as an added value service – there’s not much added value if your new rate is well below what you had been receiving. Of course, you and the TD provider can’t do much if the broader interest rate market has fallen but at least by acting on the maturity notice you’ve got a chance to think about whether the new rate is what you need.

Banks and other TD providers are required to let you know in advance that your TD is about to mature, however it is up to you to act on that by letting them know what you want to do next.

The pitfalls of auto-rolling term deposits:

  • If you have made the set and forget decision to allow them to auto-roll it, you may find yourself on a significantly lower rate than before (conversely, rates could have gone up too)
  • If you don’t instruct them to act one way or the other (reinvest or cash it in), they may automatically reinvest it, regardless of the prevailing rate.

The positives of auto-rolling term deposits:

  • The provider has to notify you before maturity, so you have the chance to act
  • You have the right to overturn an ‘auto-roll’ decision before the maturity date (but not after)
  • For some, auto-rolling of TDs is one less investment decision they have to make (which is OK if you’re not going to be worried by, for example, a lower reinvestment rate)

The overriding theme here is to be pro-active in managing your term deposits. Don’t just let your term deposits be lazy money at maturity ”“ take advantage of the maturity notice from your provider to actively think about whether or not you should:

  • Change the term for a better rate?
  • Change the term to one which better suits coming needs for capital?
  • Split the capital into more than one TD? (different terms & different rates)*
  • Change the financial institution where your capital is invested? (competition for deposits is never static)
  • Automatically roll it over for the same term at whatever rate is going with the same financial institution?
  • Withdraw the money (will you need the money at maturity)?

* This is sometimes called ‘laddering’, one of several term deposit investment strategies.

One point to keep in mind about term deposits is that if you have to withdraw the money before maturity you’re probably going to suffer an interest rate penalty ”“ some can be quite harsh. In fairness to TD providers, the penalties are designed to stop people using term deposits like a transaction account. After all, in effect they ‘borrow’ money from investors for an agreed term and then lend it out assuming the agreed term will not change.

Notes from RaboDirect:

RaboDirect works very transparently with its term deposits. All customers are informed well in advance of their TDs maturing, and are given rate information at hand, both in the email and via a click-thru to a full rates table. That way TD customers can make informed decisions about their next investment decision.