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Term Deposits. Do they make good investments?

Term deposits. Banks talk about them all the time. They mention interest rates and maturity rates but we want to look at them more broadly from an investment perspective. Do they make good investments?

What is a term deposit?

A term deposit, as the name implies, involves depositing money with an authorised deposit-taking institution (ADI) for a set period of time. Typical investment periods can be anywhere between one month all the way up to five years. Interest accrues over the life of the deposit, and is either paid periodically or, more commonly, at the end of the term.

For example, a $100,000 term deposit with Bank A for a term of one year at a rate of 2.5% per annum would return $102,500 back into your bank account at maturity. Alternatively, Bank B might offer you a rate of 2.7% per annum if you invest for two years, with interest paid annually.

What else should I consider?

The interest rates offered are based on a range of factors, including the type of depositor (e.g. an individual, SMSF, corporation), the proposed term, and what the ADI’s internal requirements for deposits are. Essentially, banks use deposits to make loans to other customers, charging borrowers a higher rate than what they pay for deposits.

Term deposits are very difficult to break once they are established. Generally speaking, if you wish to break a term deposit before its maturity date, you would need to provide at least 31 days notice, and you may also be charged an early withdrawal fee which would reduce your overall return. If having access to your cash quickly is important, you could purchase a one month deposit, but at the current rate of about 1.9% per annum, you would be sacrificing 0.3% per annum compared to a six month term deposit (Figure 1).

When investing money at set rates, reinvestment risk is worth considering. When it comes to term deposit, reinvestment risk relates to your bank or ADI not having attractive interest rates when you have cash available to invest. Shopping around for the best rate would be time consuming and create an administrative burden.

Are Term Deposits worth it?

Term deposit rates are currently very low. After accounting for inflation the real return is close to zero, meaning your cash, while safe, is not really working very hard. Because term deposit rates are connected to bank profitability, there is no guarantee that if the RBA increases the cash rate that term deposits will follow.

Generating a sufficient, reliable income in today’s market requires consideration of a wider range of options. Cash provides stability, but the price of that stability is high in the form of foregone returns. Daintree’s low risk approach seeks to achieve a better balance between income and flexibility by investing in high quality and readily tradeable credit securities.

This is the opinion of the author, Brad Dunn, Senior Credit Analyst. It not considered financial advice.