DISCLAIMER: Before I start here, please note that I am not a financial advisor and you should not use this information as advice. It is purely my thoughts on the topic and should not be used for your own decision making. Please make sure you do your own research and seek professional advice.
WHAT IS A TERM DEPOSIT?
A term deposit is where you give a bank or financial institution a determined amount for a determined period of time. The bank will reward you for the term of the deposit by paying you interest.
There are three main features of a term deposit:
Interest rate– Term deposits have fixed interest rates, so there wont be immediate changes in rates, unless you have a short-term length. Generally Term deposits are between 2-4%. In 1985 term deposits have around 12% p.a. interest rates, now they are around 3%. It is important to shop around and lock in the best interest rates, as this is the most important variable of this investment.
Generally the longer the length of the term deposit the higher the interest rate, however it will max out around 36 month’s.
Term – Term deposits represent the length of time, which the bank holds the investment. Generally the shortest term is 1 month and the longest term is 60 months. The ultimate term deposit strategy would be 60 term deposits of 60 months all rolling and that way you would constantly have income flowing. However we all have to start somewhere an its certainly not with 60x $5K deposits or $300K investment.
Ideally we need to start with 2x$5,000 deposits this will kick start the process.
Deposit amount– ranges from around $5,000 to around $2M. As an example from CBA term deposit rate website
60 months $5,000 = 1.90%
60 months $10,000 = 2.65%
60 months $50,000 = 2.75%
Other additional features include:
Rollover – At maturity date there are generally a few options, which can occur to the investment.
- Automatic rollover into the same terms and conditions and the interest earned just gets added to the investment
- Payment of principal to separate account and then the same term deposit is made.
- Pay entire amount into another account
- Keep in a holding account for a few days until you make a decision
If you are going the snowball technique of investing for further passive growth we want the interest to be paid into our snowball account where we invest on a regular basis into new investments.
Withdrawal penalties – Now say you weren’t laddering your ter deposits and you invested your whole investment into one term deposit and posted it there for 60 months. After 2 years you have a medical emergency and require the funding so you withdraw the term deposit. This will mean you get your money back but you will incur an admin fee.
Minimum investment– $5,000
Maximum investment– $2,000,000 per term deposit if you had more than you probably don’t need to be reading this.
Interest payment frequency – Banks can pay as regularly as fortnightly u to on maturity of the term deposit. Generally the more frequent the interest payment, the lower the interest rate you would receive. This is to factor in the admin costs of the payment. The most popular time frames would be as infrequent as possible i.e. yearly or on maturity.
With these articles I really want to get into the more advanced ways of doing things, yes I want to understand the basics and be able to explain it well. But I want to test the boundaries of these topics.
WHAT ARE TERM DEPOSIT STRATEGIES?
The most common term deposit strategies are as follows:
- Laddering strategy – see below.
- Barbell strategy – focus only on short term and long term, no mid term investments.
- Bullet strategy – all term deposits release on same date. Great if you need the cash on a certain date.
- Bump up term strategy – Allows you to take advantage of rising increase rates.
- Step up term deposit – Same as bunp up but usually at pre determined intervals.
- Brokered term deposit – a financial advisor can give you access to more options but for a fee.
Laddering Strategy 1
For this example we are going to be using 3 term deposits at $5,000 each:
Term Deposit 1 – $5,000 for 1 month at 1.6% p.a. ($80 p.a. or $6.6 p.m.)
Term Deposit 2 – $5,000 for 2 month at 1.8% p.a. ($90 p.a. or $7.5 p.m.)
Term Deposit 1 – $5,000 for 3 month at 1.9% p.a. ($95 p.a. or $7.9 p.m.)
1 Jan – Enter in all 3-term deposits
1 Feb – TD 1 expires and you collect your $6.60. You re-enter in for another month.
TD 2 still in progress.
TD 3 still in progress.
1 Mar – TD 1 expires and you collect your $6.60. You re-enter in for another month.
TD 2 expires and you collect your $15. You re-enter in for another 2 months.
TD 3 still in progress.
1 Mar – TD 1 expires and you collect your $6.60. You re-enter in for another month.
TD 2 still in progress..
TD 3 expires and you collect your $23.70. You re-enter in for another 3 months.
HISTORY OF TERM DEPOSIT RATES IN AUSTRALIA
As available from the RBA website 16% is the highest interest rate ever offered, with 2.2% being the lowest rate ever offered. 16% was in October 1989 and 2.2% is the current rate offered. Therefore you can see the current term deposit rates are the lowest they have ever been. So why is this the case?
Well there are several macro economic factors, which are involved in the interest rates offered by banks: BBSW’s, Cash rates, GDP, inflation rates, and unemployment rates are just a few.
Overall banks are just not as hungry for term deposits as they historically use to be and because of this they can offer a lot less for them. They are less hungry for them as there is greater profitability offered from wholesale funding options as opposed to funding from internal sources. Alternative funding options are now the preferred option.
As issued by APRA via APS 210 in the Liquidity Coverage Ratio or LCR was a component of the Basel III package to reduce financial stress and increase resilience. January 2015 when there was an introduction of the liquidity coverage ratio the yields given were very juicy however since then the rates have been on a slow and steady decline to the lowest historical rates ever offered in Australia.
The details of the letters sent from APRA can be found here https://www.apra.gov.au/adi-consultation-packages
The predictions for future term deposit rates are not good – I cannot see the rates ever going back to what they were in the 80’s and expect to see them continue around 2-3% for the next 10 years. Let me know what you think and where you see term deposit rates in the mid to long term.
ADVANTAGES AND DISADVANTAGES OF TERM DEPOSITS
A term deposit is where you give a bank or financial institution a determined amount for a determined period of time. The bank will reward you for the term of the deposit by paying you interest.
Like all investment options there are advantages and disadvantages. We wanted to cover the main advantages and disadvantages so you can make an informed decision as to whether this is an appropriate investment option for you.
Advantages of term deposits:
Low-risk investment– If you have a low-risk appetite, Term Deposits are a great investment option. The safety of your principal, which is the amount you’ll invest, is almost assured.
Term lengths– You can invest in an Term Deposit for a duration as short as 15 days or as long as three years or more.
Variability in cash flow– ypu have the option of selecting how frequently you want the interest payment to be whether it is – Every month or quarter.
Highly liquid – FDs are highly liquid. What it means is, you can close your FD account anytime you wish. You can do this online or by visiting your branch. You can ask the bank to credit the FD principal and interest to your savings account. Or, you can choose to receive the amount by check. Be aware, however, your bank may levy a penalty, or apply a lower interest rate, if you close your FD account before it matures.
Term Deposits are Insured– The Australian Government insures your Term deposit account up to $250,000. https://www.fcs.gov.au/Due to the financial claims scheme. Under the terms of the agreement if you had $250,001 in one term deposit you would lose the $1, however if you split the investment into $200,000 and $50,001 then it would all be saved.
Interest Payout Options –You can ask the bank to pay the interest on your FD on a monthly or quarterly basis. Or, you can opt to get the interest when your FD matures.
Disadvantages of term deposits
Low Returns– Term deposit returns are low compared to other investment options and if the inflation is very high fixed deposit investors are the worst hit as the return from fixed deposit may not be sufficient to cover the high expenses due to inflation.
Flexibility– No flexibility to access your funds:
Because your money is locked away with the bank, often for months (sometimes years), you lose the flexibility of a regular, day-to-day savings account.
No Diversification– If one invests all of his or her money in fixed deposits then he or she may not enjoy the benefits of diversification which one get if one invests the money in stock market, real estate, gold and other alternate investments.
Taxation– As far as taxation is concerned fixed deposits are taxed at normal rates of taxation and hence one cannot take the tax benefit from this investment.
Early Withdrawal– If you need to remove your money before the maturity, you will be able to do so by either losing the interest that you were supposed to earn or paying charges on it.
WHICH BANK IS OFFERING THE BEST TERM DEPOSIT RATE – DECEMBER 2018?
The best website to use to find this information out is ratecity.com.au, I have used this website so much over the past couple years. The information has been accurate and highly relevant so I highly recommend using it.
Please find Rate City via this link www.ratecity.com.au
They are able to provide comparable information on home loans, personal loans, car loans, credit cards, superannuation, savings accounts, term deposits, and bank accounts.
The highest term deposit rate offered at December 2018 is by AMP, with the following conditions:
Max Rate 3.15% p.a for 60 months (5 years).
Min Deposit $25,000
As part of this term deposit any amounts up to $250,000 per customer are protected by the Australian Government guarantee. Visit fcs.gov.au. You will receive your interest earnings at the end of the term or, if you would like to be paid more frequently, at a slightly lower rate on terms of one year or more. You can receive those earnings every month, every three months or every six months instead of annually.
TERM DEPOSITS – WHICH TERM IS THE MOST LUCRATIVE NOW?
The best website to use to find this information out is ratecity.com.au, I have used this website so much over the past couple years. The information has been accurate and highly relevant so I highly recommend using it.
Please find Rate City via this link www.ratecity.com.au
They are able to provide comparable information on home loans, personal loans, car loans, credit cards, superannuation, savings accounts, term deposits, and bank accounts.
The most lucrative term as at December 2018 is 60 months or 5 years, this will be able to obtain you a 3.15% p.a. interest rate. The term deposit is offered by AMP and can be found by following this link https://www.amp.com.au/personal/banking/products/term-deposits
As part of this term deposit any amounts up to $250,000 per customer are protected by the Australian Government guarantee. Visit fcs.gov.au. You will receive your interest earnings at the end of the term or, if you would like to be paid more frequently, at a slightly lower rate on terms of one year or more. You can receive those earnings every month, every three months or every six months instead of annually.
The next best term is a 6-month term offering a 2.75% p.a. on amounts over $1,000 offered by U-Bank, which can be found through following the below link.
So the clear takeaway from this you need to shop around and make comparisons of the best term lengths. The longer terms will generally obtain you a larger interest rate, however this is not always the case as the 6 month term deposit which was the second highest term offered, is less than a 12 month term deposit offering a lower interest rate.
ARE TERM DEPOSITS WORTH IT?
Growing up term deposits use to be an extremely common investment, however now you hear of them less and less. I was under the impression that a couple years ago the term deposit rates were actually less than the rates which the bank offered on the newer products being the high interest online saver accounts. So I decided to do some research.
When I jumped onto Commonwealth Bank of Australia’s website I could see the following:
The most lucrative term as at December 2018 is 60 months or 5 years, this will be able to obtain you a 3.15% p.a. interest rate. The term deposit is offered by AMP and can be found by following this link . https://www.amp.com.au/personal/banking/products/term-deposits
The most lucrative saver account as at December 2018 is an AMP Saver Account – a $10,000 balance will generate 2.55% p.a. over the first 4 months and then base rate of 1.8% following that. .
As you can see the interest rate is larger on the term deposit but of course you have to consider the negatives of a term deposit.
So to conclude there is some merit in opting for a term deposit, as the rates are slighter larger than the standard no special of the month offer by other banks.
ARE TERM DEPOSITS SAFE?
When I read this question, there are two forms of safe, which come to mind:
- Safe as in if the government was to collapse, is my term deposit still safe;
- Are term deposits risky
1. Under the Australian Governments Financial Claims Scheme (FCS), account holdersare protected up to $250,000 for deposits at each bank, building society and credit union incorporated in Australia.
If a bank was to fail in Australia, the government can activate the FCS, which allows accounting holders access to their money.
Under the FCS an account holderis an individual, body corporate, partnership, association, trust, superannuation fund, with an eligible account at a bank, building society or credit union incorporated in Australia.
If you had $250,000 in your savings account with Commonwealth Bank, and $250,000 in an account with ANZ, and they were to both folds then you are entitled to receive both accounts of $250,000 back.
If you had two accounts in the same savings account exceeding $250,000 you would only receive up to $250,000.
Overall, it is very unlikely that the bank will be unable to pay you back for your term deposit. Especially if the investments are under $250,000.
2. Risk comes from the chance of losing your money or the safety of your principal, which is the amount you’ll invest. When investing in term deposits there is little to no risk of losing your money. This is unlike other investment alternatives such as the share market or real estate where an investment can go sour and you may not receive your principal back.
To conclude, a term deposit is an extremely safe investment option coming from the two perspectives addressed above.
ARE TERM DEPOSIT RATES GOING UP?
I am going to start this one off saying in no way can I predict the future and whatever I argue here could be completely wrong. So what I am going to do is offer my point of view and explain why I justify my choice.
No term deposit rates are not going up – per the historical RBA 1 year term rates on a $10,000 term deposit the current interest offered is the lowest in the history of data collection.
I have explained the reasons why the term deposits are offering such low rates in this article here.
So no I don’t think interest rates are going up- the reason why I don’t think they are going up is that it is more profitable for a bank to obtain alternative sources of funding other than internally generated term deposit sources. Therefore the banks are not interested in building up their book of term deposits, and can offer a rate, which is not very enticing to customers. I don’t see this changing anytime soon and therefore I do not see the interest rates going up.
There may be small fluctuations in term deposit rates over the next few years, but the overall trend I expect to remain consistent with current rates.
ARE THERE ANY COSTS INVOLVED IN GETTING A TERM DEPOSIT?
For the majority of banks there are no costs involved in setting up a term deposit. You will receive interest payments based on the duration and amount of your term deposit. There will be costs incurred if you want to withdraw the deposit before the maturity date.
HOW MUCH DO I NEED TO GET A TERM DEPOSIT?
This will depend on the bank however some banks such as Bank Australia offer $500 minimum to invest in a term deposit, whilst at UBank the minimum amount was $1000.
CAN YOU LOSE MONEY IN A TERM DEPOSIT?
Under the Australian Governments Financial Claims Scheme (FCS), account holdersare protected up to $250,000 for deposits at each bank, building society and credit union incorporated in Australia.
If a bank was to fail in Australia, the government can activate the FCS, which allows accounting holders access to their money.
Under the FCS an account holder is an individual, body corporate, partnership, association, trust, superannuation fund, with an eligible account at a bank, building society or credit union incorporated in Australia.
If you had $250,000 in your savings account with Commonwealth Bank, and $250,000 in an account with ANZ, and they were to both folds then you are entitled to receive both accounts of $250,000 back.
If you had two accounts in the same savings account exceeding $250,000 you would only receive up to $250,000.
Overall, it is very unlikely that the bank will be unable to pay you back for your term deposit. Especially if the investments are under $250,000.
WHAT HAPPENS WHEN A TERM DEPOSIT MATURES?
At maturity date there are generally a few options, which can occur to the investment.
- Automatic rollover into the same terms and conditions and the interest earned just gets added to the investment
- Payment of principal to separate account and then the same term deposit is made.
- Pay entire amount into another account
- Keep in a holding account for a few days until you make a decision
There we have it guys, the complete term deposit guide. If you have any feedback or comments on it please let me know!
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