Term deposits better then shares
With some five year term deposits now offering interest rates above 7 per cent some investors may be wondering whether it’s worth locking in some of these returns.
Although there continues to be speculation of more official interest rate rises beyond the current 4.5 per cent cash rate determined by the Reserve Bank of Australia, whether this flows though to term deposits isn’t certain.
Back in July 2008, for example, when the official cash rate was 7.25 per cent, some banks were offering just under 8 per cent and you could get 8.25 per cent for one year term investments. But three year deposits were offering less than 5 per cent. These days with the official rate at 4.5 per cent, three year term deposits are offering up to 6.8 per cent.
The challenge for long-term interest seeking investors who like the security offered by term deposits, says financial planner Peter Crump of Portfolio Planning Solutions, is juggling the terms. While chasing shorter term “specials” can be rewarding, this strategy can also be exhausting and over the longer term may not necessarily lead to higher returns.
With term deposits, there is always the issue of the rate that is being offered when the time comes to roll over your investment. There is no guarantee that what you may be offered for the same term will be better that what you have been earning. A year ago when the official cash rate was 3 per cent, one year deposits offered 3.7 per cent and three year deposits 5.4 per cent.
The trouble with locking into a three or five-year term because the instrument offers the best return at a particular time is the possibility than in a year from now the return being offered may be better. Compare last year’s three year offering of 5.4 per cent with this year’s 6.8 per cent for the same term. It means you face the prospect of getting one to two per cent less interest for the next two years.
One way of juggling interest rates offered by different period term deposits is to consider a portfolio approach where you invest in deposits with a series of maturity patterns.
If you think that a five year rate offering 7.5 per cent could be close to the best you may get for the next few years, you might commit half or two-thirds of the money you are prepared to allocate to term deposits to this longer term. Just in case rates go up, you leave some of your money in a shorter period, say a one year term deposit currently offering 6.5 per cent. If rates go up to 8 per cent, this will provide some compensation for the lower return on the money you locked away.
A more sophisticated version of this strategy is to split the balance between three, two and one year deposits. Next year when the time comes to roll over the one year deposit, you can pick the term that offers the best return. This could be any term up to five years. This exercise is repeated the following year when the two year term deposit matures and the next year when the three year deposit matures.
The attraction of this strategy is that each year there is at least some money that can be reinvested in the term that offers the best rate.
About author
Aaden Wynn is an experienced financial advisor who is writing article on Online Banking and other financial matters. According to him, Term Deposits is a plan and program which should be worth noticing.
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