The Benefits Of Term Deposits – Are Term Deposits Worth It?
Three years ago I sold a bunch of assets and found myself with around $20,000 in cash that was unaccounted for. Some refer to this as a ‘lump sum of money’ or a ‘windfall’ – to me it was simply releasing the years of equity I had built up via car loan repayments and other deposits (can you guess the asset?). I was owed this money from all of my hard work.
At the time I had no debts, no goals and nothing I immediately needed to buy – I was a free agent with only one mission for my money: to use it to make more.
To do this, I needed an investment plan.
I pondered ideas like investing the money in the share market, buying an apartment or perhaps even using it to start a business. While all good ideas, none of them were ideal given my particular circumstances.
At the time I was risk averse due to some significant losses I made in my first foray into the share market (just before the GFC hit, yep you guessed it – all gone). I also potentially needed to access this new $20,000 in the coming months to a year in order to purchase my first house (to live in).
My desire to invest was two pronged; firstly, I wanted to make more money. Secondly, I wanted to invest it now so I could remove the temptation to frivolously spend the cash on things like going out, the movies, dinners and other day to day activities that have a habit of deleting 0’s off the end of your bank balance.
This is when I stumbled across term deposits and their benefits.
A term deposit allows you to invest your money, at a set interest rate, for a particular amount of time. For instance, the longer you opt to have your money in a term deposit – the greater the amount of interest you will earn.
The term deposit in turn earns you interest while protecting your money from impulse spending. The perfect combination for someone like me wanting my money to immediately start earning interest while still also sheltering it from my urges to spend.
So, when is a term deposit worth it?
People often ask whether or not term deposits are worth it. Is it worthwhile locking your money away in a term deposit when so many other options exist for earning interest on your cash?
The interest rates on term deposits are often slightly more competitive than a high interest saver account as they allow you to lock in a set rate for the entire ‘term’ of your choosing. While some high interest accounts may offer a higher ‘headline rate’, they are more susceptible to rate changes and have the ability to go up and down more frequently.
To get a higher term deposit rate however you need to be willing to select a longer investment time frame. The banks and credit unions want to reward customers with more interest for giving them your money for longer.
Here are the top four reasons that a term deposit is indeed worth it:
- You want a safer, cash only investment in your portfolio
- When you are lacking motivation and want to start saving
- When you have a lump sum of money you want to use soon
- When you need to think over how to use your cash
For me, I see a term deposit as yet another way to grow my savings. Yes there are many options out there such as high interest accounts, managed investments and more – however a term deposit require little to no investment knowledge in order to obtain and quickly provides you with real earnings on your money.
What are the benefits of term deposits?
To condense my small story above, essentially the benefit of a term deposit is that they are simple, risk free and easy for the average investor to utilise. Though for those of you needing more information, the benefits of term deposits are:
- Little to zero risk of losing your money
- Locked in interest rates that earn for the full ‘term’
- Your money is locked away (out of sight, out of mind) so no impulse spending
- Term deposits are a motivational product that helps build out your savings strategy
- A good set and forget style investment
Ok so I’ve spent a little time outlining the pro’s of term deposits when it comes to saving money; though what about the downsides? Do term deposits have any negative aspects? Let me explain further.
What are the negatives of term deposits?
The interest rate is fixed (it may go up while you are locked away)
For example, you might take out a term deposit for 12 months at a set interest rate. After 3 months, the rates go up – meaning you are stuck with a less favourable rate than new customers could get if they signed up.
You can’t add any further money until the time period is up
Unlike a high interest savings account, a term deposit won’t allow you to add extra money to it throughout the ‘term’. So if you lock away money for 12 months, you cannot add another dollar to it until that 12 months is up.
To combat this though, people often simply open numerous term deposits to keep the money locked away and growing.
The earnings you make from interest can struggle to beat inflation
Inflation is the increase in the cost of living. A dollar saved today might only be worth 80 cents in a few years time as products and services get more expensive. Inflation is normally between 1 and 4 percent each year, so remember that you money needs to beat this return each year to ensure it’s actually growing or maintaining value.
For those of you unfamiliar with inflation, read our guide to what inflation is here.
Interest not paid monthly (quarterly, six monthly, annually or at maturity)
Most high interest accounts calculate interest owed daily and then pay monthly. This means the following month you earn interest on your investment AND your newly earned interest. This is called ‘compound interest’.
Term deposits however rarely pay interest each month. Instead most term deposits pay interest either quarterly, every six months, annually or at maturity (when the term is finished).
A quick checklist of things you need to watch out for:
Leave enough money in your high interest saver for ready access if need be
People over commit to term deposits and put every single dollar they have. Don’t do this. You need some back up money should you need to dig into your savings for an emergency.
If all of your money is locked up in the term deposit, the desire to cancel your term deposit early gets greater as you need to access the money. This costs you in fees, charges and sacrificed earnings – so assume you will need some cash outside the term deposit just in case.
Cancellation fees – what is the cost of cancelling early?
Find out up front what the cost is to you if you cancel your term deposit early.
Cancellation percentage – do they take a percentage of original cash?
Check that the bank doesn’t take a percentage of the original cash investment for any early cancellations. While sacrificing interest is one thing, losing original cash is another and unacceptable.
Whether you lose all interest earnings if you cancel early
Find out if you don’t get any interest should you cancel early. E.g. if you earned 6 months worth of interest in a 12 month term deposit, do you sacrifice all of that if you cancel early?
The interest rate starts the minute you open the account so be quick
Something people often don’t realise is that the term deposit interest rate is a per annum figure, e.g. you will earn that percentage over the term you choose. If you dilly dally around and don’t transfer your cash into the term deposit quickly, you are reducing your interest rate as each day it’s not in the term deposit, you are losing money.
Look for details on when interest is paid
Consider what I mentioned before about compound interest. Check that the term deposit you fancy hopefully pays interest more frequently than on ‘maturity’.
Are term deposits safe?
Regardless of the pro’s and con’s of term deposits, if you are like me – you are probably only reading this and considering a term deposit because you have heard that they are a safer, lower risk investment.
But what actually makes term deposits safe?
Government protection of balances up to $250,000
I won’t bore you with Government policy, though the Australian Government offers a Guarantee Scheme for deposits up to $250,000 (per customer, per bank or institution).
This means you are protected for up to $250,000 per bank you are with for your savings. This was introduced around the time of the GFC to make people feel more comfortable about leaving money in the bank.
Tip: If you were lucky enough to have more than $250,000 in cash at the bank, you should consider putting $250,000 across multiple banks. The way the policy works is that you are covered for multiple balances of $250,000 as long as it’s with different banks.
No correlation to the share market (or very little)
With a term deposit, you are not investing in companies or shares of any kind. It is a cash deposit and the bank rewards you for depositing the money in the form of interest. They make this interest by lending your money to others (in the form of home loans) at a higher interest rate.
While interest rates can indeed change due to consumer sentiment on the share market, there is no correlation between term deposits and the share market beyond that.
Fixed interest rate
Another reason term deposits are safe in many peoples eyes is that the interest rate is set at the beginning of the term, giving stability and knowledge of exactly how much money you are going to make.
Term deposits or high interest online savings account?
People question whether a term deposit is worth it considering that a new breed of online savings account has emerged (HISA’s).
Yes a high interest savings account can provide the same if not better interest rates, but they still have one point of difference. Money is easily withdrawn from a HISA, where as a term deposit locks your money away.
If you have trust issues about impulse spending, consider a term deposit. If you trust yourself to never withdraw your savings? Go a high interest savings account.
Or you can do what I do; have both. Lock away your main savings and use your HISA to grow your next term deposit and save your day to day left over money.
Term deposit FAQ’s:
Why do I always see ‘special term deposit rates’ when at the bank?
They want your money. It helps them add to their cash reserves. It’s cheaper for them to use deposits to lend out then borrow money from larger pools of credit worldwide.
Interest rates on large sums of money are negotiable with banks
Did you know that if you have a large sum of money, you can walk into your bank and discuss a better term deposit rate than what you normally get offered? Banks want large deposits and will do whatever it takes to get them.
Can my term deposit keep going after the initial term?
Yes, this is called rolling over. You can opt to have your term deposit roll over into a new term deposit after the end date.
It’s advisable however to always shop around, if you simply tick the ‘rollover’ box when opening a term deposit, you will not be easily able to check your new interest rate come time.
What are the common investment terms for TD’s?
- 90 days (3 months)
- 180 days (6 months)
- 1 year
- 2 years
- 3 years
- 4 years
- 5 years
So whats your point?
Personally I see term deposits as just another tool at my disposal – to save money I often need to deploy a range of tactics to motivate myself, protect myself and grow my money.
This is why I choose to have a term deposit as part of my personal savings strategy. I use them for lump sums as mentioned at the start of this post + I now have a new strategy.
My new strategy involves using a HISA to save as much as I can. Once I save over $2,000 I opt for opening a term deposit to lock it away. I then make a game of it to try and save another $2,000 before the term deposit expires. Doing this means I am collecting more and more money and eventually can roll them all together to make a super term deposit.
While some may debate the merits of term deposits, it really comes down to you and how you see your savings. Some don’t trust themselves to not withdraw their savings each time they need some money, while others are drawn towards term deposits because they contain little to no risk of losing money.
Term deposits really are an ‘each to their own’ style of investment but a great way to earn interest on cash you have no plan for.