Often viewed as short term parking funds, term deposits continue to earn their place as a savings and investment option, but there are pros and cons of term deposits. There are also hybrid products available combining term deposits with higher interest bearing accounts.
As far as cash-style investments go, term deposits may seem a little old fashioned. What is it about these investments that continue to attract customers, and how have they evolved throughout the current low interest rate environment?
A term deposit (TD) is an investment that yields a rate of interest which is guaranteed not to change for the nominated term. This means that you’ll always know what your savings are worth.
Another advantage is that at times when interest rates are in decline, your fixed rate can’t be affected. Conversely, if interest rates rise, you could be disadvantaged by being locked in to a rate lower than current cash rates. Some people accept that risk as a trade-off for the confidence afforded by the security of a TD.
A further disadvantage of a TD is that money invested is generally not accessible during the term. If the conditions of the TD allow for withdrawals during the term a penalty usually applies.
One of the most common uses of a TD is as a parking space for cash between investments.
For example, when Sarah was offered a promotion that required a move to Sydney, she and her husband Peter sold their Melbourne home. They planned to buy in their new city once she’d settled into her job.
Initially the couple rented an apartment while they looked for a suitable home to buy. Before they commenced their six-month house hunt, they deposited the sale proceeds of their previous home in a TD knowing that their capital was secure and would earn a small return during that time.
As part of a savings plan, TDs are often overlooked for more “trendy” investment options such as mortgage trusts and international money markets. When structuring a diversified investment portfolio it is good practice to consider all the options available.
A combination of both
A number of financial institutions offer TD-style products that are a combination of term deposits and high interest savings accounts. These products have no set term but notice must be given before funds can be withdrawn. Generally the more notice given, the higher interest rate is paid, albeit this rate is variable, not fixed. Deposits can be made at any time.
People for whom capital security is paramount, retirees for example, may favour the defensive nature of TDs or these hybrid accounts.
Any financial product should be viewed as part of an overall financial strategy that aims to meet the goals of the investor. For this reason, even though TDs and other fixed interest and cash investments come with a higher level of security, speak with your Hudson adviser prior to making any decisions.