Interest yielding bank products are probably one of the least risky ways to grow your personal wealth. This is because the government guarantees all bank deposits up to $250,000 per bank, called the Financial Claims Scheme.
If you have concerns about the future of the share market, perhaps you foresee global catastrophe for example, savings accounts and term deposit products are a more reliable way to generate returns. Like any investment though, there are drawbacks that come with the benefits. For term deposits, the main consideration is how long you want to lock your money away.
What is a term deposit account?
Term deposits are an interest-yielding product available at most banks, similar to savings accounts. A term deposit will have both a fixed term and interest rate. If you put your money in the account and do not withdraw it until the term is concluded, you receive the interest payment in full.
Let's say you find a one year term deposit product, with a minimum deposit size of $5,000, a 4.50% p.a interest rate with end of term payments. You would deposit however much you wanted (we’ll just go with the minimum $5,000), and then leave that money for the full year.
Once the period was up, you would then be able to withdraw the $5,000, and receive an additional $225 interest payment ($5,000*0.045). Interest paid on deposit products is considered taxable income, so you will be taxed on this amount accordingly.
You usually have to nominate a bank account that the interest is paid into - banks usually like it to be their own account, but you might be able to nominate another. Many term deposit products give you the option to have interest paid monthly, quarterly, six-monthly, annually, or at maturity. Higher interest rates are typically applied to annual or at-maturity payments. Term deposit rates also have historically been higher for longer terms and larger deposit sizes.
Long-term term deposit rates
Traditionally, term deposit rates have moved similarly to the RBA cash rate. When the cash rate is high, term deposits will typically also have a higher yield, and the same applies when rates are low.
‘Long term’ generally refers to anything longer than a two-year term. Terms up to five years are typically available.
Pros of long-term term deposits
There are several reasons that make locking your money away for a few years an attractive investment option.
1. Guaranteed returns
When you put your money into a term deposit, you know that if you satisfy all the conditions, which usually just means you don’t withdraw the money early, you will receive the interest payment in full. Term deposit rates are fixed, so do not change regardless of alterations to the cash rate and other market fluctuations.
2. Minimal risk
Term deposits are also covered by the Australian Government Financial Claims scheme (AGFC), so even in the extremely unlikely event the bank goes under, your deposits are protected up to $250,000. This only applies to Authorised Deposit-taking Institutions (ADIs) regulated by APRA.
There are more than 100 individual ADIs registered in Australia. Be aware that some banks share banking licences, like UBank and NAB for example.
3. Low fees
Most term deposit accounts don’t have fees for establishing or maintaining an account.
4. Minimal fussing around
Many of the highest-interest savings accounts require you to make minimum monthly deposits, transactions, and other hoops to jump through. Some also may require you to grow the balance or not withdraw anything. With a term deposit, you can just set and forget (but you can’t withdraw).
Cons of long-term term deposits
Like any investment option though, there are also drawbacks to putting your money in term deposits for a few years.
1. Lower returns
While term deposit products often have higher rates than savings accounts, a general principle of investing still holds: less risky investments usually means less returns. Term deposits offer guaranteed, almost risk free returns, so do not have the same potential as investing in equity markets or other securities. It’s worth considering the opportunity cost of putting your money in a term deposit (the potential returns you could have got investing elsewhere).
This also depends on your appetite for risk and investment timeline. If you are a retiree or near retirement for example, you might not want to chance your money in shares or other investments.
2. Risk of rate change
While fixed rates can be a big positive if rates go down in the meantime, you also run the risk of interest rates going up during your term. Imagine someone who opened a one year term deposit account in May 2022, for example, when the average return for one year term deposit products was just 0.40% p.a. This individual would have been dismayed as over the following year, term deposit rates steadily rose, reaching 3.25% p.a for one year terms by May 2023. They would still only receive the initially agreed interest rate, so it’s worth remembering this risk.
4. Early withdrawal penalties
While term deposit rates are guaranteed, this only applies if you do not withdraw the money early. Many term deposit products have penalties for early withdrawal, including reduced or even eliminated interest payments.
5. Simple interest payments
Most term deposit products have what’s called simple interest. This differs from savings accounts which have compounding interest - usually calculated daily and paid monthly. Compound interest essentially means your interest earns interest.
At set intervals, term deposit interest will be paid based on the principal. While it’s possible to rollover the balance at the end of the term, the payments during the term are simple, not compounding.
On smaller deposits and shorter terms this might only add up to a couple of dollars. However, for sizeable deposits and longer terms, this could be a sizeable chunk of change.
Should I put my money in a term deposit?
There are several things you should consider if you’re weighing up whether term deposits are right for you, especially at the longer end of the spectrum i.e. two or more years.
Need for liquidity
One of the main drawbacks of term deposit products is that you can’t access your money for the term length. It’s not a good idea to put money in a term deposit that you conceivably might need for living expenses down the track. If you are in a position where you need to prioritise liquid assets, savings accounts might be a better option. On the other hand, you might appreciate that a term deposit forces you to lock the money away, removing the temptation to eat into your savings.
Financial landscape
Term deposit rates are closely tied to the RBA cash rate: when rates are high, term deposits will also have higher yields. During periods of high rates, term deposits become a more fruitful option, while when rates are low, they become far less attractive.
Inflation should also be a consideration: think about late 2022/early 2023 when CPI inflation was nearly at 8%. If the cost of goods and services are accelerating faster than your term deposit rate, you are going backwards in terms of purchasing power. However with inflation this high, it would be hard to beat it almost anywhere.
Risk preferences
If you’re looking for a steady, safe way to make your money work for you, interest yielding products like term deposits might be worth considering Rates are fixed and your deposits are covered by federal guarantee, so you can sit back and watch your money grow without worrying. On the other hand, you might have run the numbers, and aren’t satisfied with comparatively smaller returns, especially since your money is inaccessible for the term length.
Things to remember
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All interest rates on term deposit products give per annum rates, which means interest is expressed as a per-year figure. If a six month term deposit product has a 4% p.a rate, that means you would earn 4% on your deposit size in a year, not in six months.
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Only term deposits from registered ADIs with APRA fall under the $250,000 guarantee. If you find a term deposit product from an unregistered institution, there is no guarantee that you will get your money back if it collapses. There’s also a good chance the product you’ve found is misleading and is not a term deposit at all, rather another investment product - so be vigilant.
