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Term deposits

by Ben Power | 19 Dec 2012

Term deposits – offered by the likes of banks and building societies – lock in savers for a particular time: anywhere from 30 days to five years.

The money deposited can’t be accessed during that time without triggering steep penalty fees.

Unlike volatile share and bond portfolios, the value of your investment in term deposits doesn’t change. Despite this capital guarantee, term deposit interest rates are high and attractive, relative to shares and bonds. The interest rate – or return – is also guaranteed for the period you invest.

“They (term deposits) are back in fashion at the moment,” said Greg McAweeney, general manager of RaboDirect Australia. “They’re quite popular with self-funded retirees because they give a guaranteed return. The on-call (regular cash accounts) interest rate can vary, and equities go up and down like yo-yos.”

Term deposits can be used as a key strategy to secure a pension for the next few years and help retirees sleep better at night.

But it’s important to shop around.

Look at your options

Competition for retail deposits has pushed term deposit interest rates to high levels compared to those available in the past.

In the wake of the GFC and encouraged by new regulations, banks and other financial institutions have moved to shift their funding away from volatile wholesale markets to more stable retail deposits.

To attract deposits they’ve upped interest rates on term deposits. Currently, a typical five-year term deposit might pay approximately five per cent, however this can fluctuate and not all term deposits are equal; rates vary across institutions. “Make sure you shop around for specials,” said Travis Morien, director of Australian Independent Financial Advisers, an independent fee-for-service financial planner. “Rates can vary widely between banks and even within a bank for different periods.” Retirees can shop around on the internet for the best deals. Canstar Cannex’s website, for example, publishes rates for term deposits of 30 days up to five years for most banks and financial institutions.

Withdrawal

The main downside of term deposits is their lack of liquidity – if you need to withdraw the money urgently then you will pay steep penalties.

The penalties vary and include reduced interest payments.

For this reason, most financial planners don’t advocate having all your funds in term deposits and advise keeping some money in regular cash accounts.

Peter Arnold, financial analyst at Canstar, warns that while term deposits are fairly simple, there are traps for the unwary, particularly relating to when the term deposit period ends or ‘rolls over’.

Your bank will generally contact you by email or letter before the roll over date. If you don’t advise them what to do, your account could automatically be rolled over into a new term deposit.

Don’t invest it all

Morien says term deposits can offer a respectable return for the conservative parts of the portfolio and can therefore be an alternative to some of the bond fund exposure. Bonds do have their advantages, including liquidity and potential for capital gains, though they can also suffer capital losses.

Stephen Hart, director of planner services at FIIG Securities, said bonds typically pay higher returns. “But they’re difficult to access by retail investors,” he said.

Michael Hutton, a financial planning partner at HLB Mann Judd, said the main benefit of term deposits is that investors can’t lose their capital.

He says term deposits are also an excellent way for retirees to manage and map out the next few years of pension payments.

As a general rule, he says it’s ideal for retirees to live on five per cent of their fund balance per year. So you might have four term deposits, each of five per cent of the portfolio, for a total term deposit investment of 20 per cent of the portfolio.

The remainder of the portfolio, according to Hutton, could then be in bonds and shares in a bid to generate a higher return, while four years’ pension is safe and sound in term deposits.

“We’re very keen for retirees to have next year’s pension ready to go into their cash account,” Hutton said. “One of the biggest problems through the financial crisis was people selling off assets at reduced values to meet pension payments.

“Putting a series of future pension payments in something such as a term deposit takes a lot of stress out of the equation.”