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Short-term deposits offer quick returns and less commitment, but generally have lower interest rates.
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Long-term deposits generally provide higher interest rates and certainty, but require financial discipline and a heady commitment time.
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6 to 12 month deposits offer a sweet spot, generally offering the highest rates yet a length that’s not too much of a commitment.
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Aligning term lengths with financial goals and assessing interest rates and economic conditions is crucial for making informed decisions.
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Having a variety of savings strategies, and different interest payments can smooth out worries over commitment.
A term deposit is a fixed investment where your money is locked away for a specified period, known as the term. In return, you receive a guaranteed interest rate. Terms can range from one month to five years, with interest typically paid at maturity or at regular intervals (e.g., monthly, quarterly).
Making a decision on which term length to pick largely involves analysing your goals, and whether they are short or longer term. This is because term deposits typically carry early withdrawal penalties, so it’s important to pick a term and a lump of cash you don’t need for that period.
Choosing the right term deposit length depends on balancing your need for cash-in-hand with your desire for higher returns. Read on to find out more.
Short-Term vs. Long-Term Deposits
Below are some key ingredients that may help you make your decision as to whether to go with a short or long term deposit.
Interest Rates
Typically, the longer the term, the higher the interest rate offered. Historically, short-term deposits offer lower interest rates compared to long-term options.
However, this is not always the case. At the time of writing, shorter terms up to 12 months offered more competitive interest rates. This can be a general indication from the bank that they prefer savers lock away for the short term, rather than have to pay them top rates for a few years.
Commitment
Obviously the longer the term, the longer the commitment. If you withdraw funds early, you will likely sacrifice a significant hit to the interest rate, plus a fee could apply. In the event that outweighs interest owed, this could come out of your capital.
On the other hand you’ll get interest rate surety and guaranteed returns, backed by the government’s $250,000 deposit guarantee. Longer terms might also suit those who wish to ‘set and forget’.
Shorter terms require less commitment, but often attract lower interest rates. You can however decide more often how to reinvest or use the matured funds - whether to roll it back into another TD, put it in a savings account, or another investment. However, this might be a negative, requiring mental admin deciding what to do with your savings.
Interest Paid
Interest rates are typically strongest on products where you have interest paid at maturity. On shorter terms, you may not get a choice on how often it is paid, and you may be restricted to only getting it paid at maturity.
With longer terms, there is often a lot more choice - monthly, quarterly, bi-annually, annually, and at-maturity. Some products even allow for fortnightly interest payments.
Choosing a more frequent interest payment, however, could yield some interesting opportunities. You could decide to re-invest that interest payment elsewhere and earn more interest or use it to cover an expense.
Opportunity Cost & Compounding Interest
Opportunity cost refers to the loss of interest-earning alternatives when one investment avenue is chosen. For example, if you locked up all your savings in one product with interest paid at maturity, you wouldn’t be able to do anything else with that money or interest.
If you have a shorter term or more frequent interest payments, interest is earned over a shorter period, allowing reinvestment opportunities. Your interest would theoretically gain more interest, which is called compounding. This is handy because term deposits by their nature are simple interest.
Over long periods, however, inflation can erode the real value of your returns if the interest rate is lower than the inflation rate. So, you’ll want to avoid locking in an uncompetitive rate if you think interest rates or inflation will go up.
Living off TD interest
If your TD balance is high enough you could theoretically live off regular interest payments. For example, if you had $1 million invested at 5.00% p.a. and had interest paid monthly you would get about $4,166 a month.
Of course, any interest earned is taxed as income. In the above example you’d earn $50,000 in interest per year, and assuming no other income was earned, you’d get a net $42,283 including the Medicare levy, or about $3,623 a month.
Laddering Strategy
Called laddering, spreading your investment across multiple term deposits with different maturity dates could be useful. This provides regular access to interest, and smooths one-time big interest payments, freeing up some cashflow to direct towards other expenses or investments. This can also act as a hedge against inflation.
Timing the Market
In a low-interest-rate environment, locking in long-term might not be advantageous if rates are expected to rise soon. Conversely, securing a long-term rate can be beneficial if rates are expected to fall.
That said, you can take advantage of rising interest rates sooner by choosing a shorter term or reinvest interest payments made more frequently.
On the flipside, you might miss out on higher rates if the market rates increase after you’ve locked in your deposit.
Choosing the Right Term Length
We’ve gone into a few strategies on short versus long term deposits above, but arguably more important is assessing your own financial goals and finding which one suits you best, regardless of milking all that you can from an account.
Look at Your Financial Goals
You’ll need to assess why you’re looking at a term deposit and what you’re saving for.
For goals like an upcoming holiday, a wedding, or a big one-off expense, short to medium term deposits would be the better bet. Schedule the term’s maturity for right before D-Day happens.
For longer-term goals like home renovations, education, or a deposit on a property, consider longer-term deposits.
You might also want to look to lock-in a long-term deposit if you are looking to retire and can’t access superannuation yet, and want a big chunk of cash plus interest for when the time comes. Or, if you’re retired and want a boost, you could put your savings in a longer term deposit with more frequent interest payments and use the interest as a regular paycheque.
On the more complex side, you could use a term deposit as a hedge against more risky investments. Say you’ve inherited a large sum of money or have sold your house and have a lot of cash reserves, you could stash some in a near-risk-free term deposit, and chase other more risky investment options such as shares.
If you have a large lump sum and you think inflation will go up, or interest rates would go down, you could hedge against this loss by locking in a term deposit and not worry about your cash.
When to Reconsider a Term Deposit
There’s a reason why in our State of Aussies' Savings report that savings accounts were the single-most popular savings method (57.3%), and term deposits were one of the least (6.5%) - flexibility.
Before opening a term deposit, many banks will ask you to reconsider a term deposit in these two key scenarios:
You Might Want to Withdraw Funds
It’s generally ill-advised to open a term deposit if you need access to those funds. Maybe it’s for an emergency, or an expense coming up within the term - in that case, it might be better to put your funds in a savings account.
Many expenses, even short-term ones such as holidays or weddings, happen piecemeal over a set period. For example, maybe you pay for flights in January and hotels in March - here you would need to dip into your savings, in which case a term deposit isn’t advised.
This is because banks, unless you’re in financial hardship, don’t want you to withdraw from the term deposit. To withdraw early, you may need to submit a form that the bank can reject. If they grant a release, you will likely sacrifice a lot of interest and maybe even face a small penalty.
If you opt to withdraw early, you will still likely need to provide 31 days' notice to withdraw. This is a liquidity and regulatory requirement for banks from APRA.
You Want to Build Your Savings
Savings goals don’t happen instantly - for example, saving a house deposit can take years and you generally direct a proportion of your paycheque every week/fortnight/month to save for it.
In this instance, a term deposit may not be the right option because you can’t add to your funds. You can open a new deposit, of course, but this might be too much work if you’re opening one every payday!
In a case like this, where you add to your savings over time, a savings account could be a better option.
Overall, term deposits offer a near-risk-free way to store a chunk of cash in a ‘set and forget' manner and earn interest. They aren’t right for everyone, and you should consider if you can afford to lock away your savings in one before opening a new account.
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