If you are looking at the low-risk option of depositing money with a financial institution, a term deposit (TD) can be a good way of getting the most out of your money from a relatively higher rate of return than a standard savings account. As with other investment products, the rates on offer from term deposits will fluctuate with the market, but there are always things you can do to make term deposits work better for you and your money.
When you take out a term deposit you lock that money away for a set period of time with a fixed interest rate.
Here are five such measures you could take.
1. Pick the right term
When taking out a term deposit, it is important to think about the tenure, or length of your investment. The ideal tenure will depend upon how long you want to put your money away for and what rates the different ADI’s are offering for different tenures. Terms generally range from one month up to five years. There are a couple of things to consider when deciding on an appropriate term length.
The first is fluctuating interest rates. For example, if you lock in a six-month term deposit and interest rates go up, you’re potentially worse off than if you were to lock in a three-month term initially and then lock in a second three-month term at the new higher interest rate. The same applies to when interest rates are going down, except that the opposite logic applies here in that the longer term you go with for your term deposit, the better the outcome if rates go down during the period of your term.
Another thing to consider when deciding on how long you should lock your money away for is when you’ll need to access to it. Accessing money from a term deposit before it’s matured can incur penalty fees which can eat into the money you are going to earn from your term deposit. Surprises are always going to happen, but you can reduce the risk of having to sacrifice a chunk of your term deposit earnings by simply thinking through your upcoming money needs carefully and making sure that you do not have any upcoming commitments that are going to require access to the funds you are looking to invest in your term deposit.
2. Understand the ‘frequency’ of interest payments
A critical step before investing in a term deposit is understanding when the interest ‘earned’ is paid. Some term deposits only pay interest once at the end of the term while some pay monthly, quarterly, or even weekly (‘compounding’ over the course of the deposit).
Some term deposits also let you take the interest earned as a ‘payment’ into a separate account – while some simply add the interest earned onto the principal amount you invested – thus adding the compound effect.
If you choose to take the interest earning payment option, it can be accessed as soon as the payments are made into the separate account, sort of like a monthly ‘income’. This option is generally not offered on shorter-term deposits (between 1 and 3 months).
3. Zero risk
Something you may not know is that all authorised deposit-taking institutions (ADIs) are guaranteed by the Commonwealth Government up to $250,000. This means that if your financial institution goes bankrupt or anything happens during your fixed term, the Australian Government will guarantee your term deposit. So investing in a term deposit with an ADI for less than $250,000 is effectively a zero risk investment.
If you are planning on investing more than $250,000 and you want to retain the protection of the government guarantee, you can still achieve the same zero risk outcome by breaking up your money into smaller sums of less than $250,000. Importantly, in order to fall under the guarantee, the smaller deposits must then be invested at different financial institutions.
4. Interest rate pricing
There is more to how ADIs price their interest rates than you might think.
As mentioned above, interest rates fluctuate with the market. While (at the time of writing) there hasn’t been any movement in the Reserve Bank of Australia (RBA) cash rate since August 2016, term deposit rates have actually moved around a bit during that period showing that for many ADI’s, the RBA’s cash rate is not the only factor which drives their term deposit ‘pricing’. Other factors, such as the level of market competition among these ADIs for term deposit business, can also drive term deposit interest rates up so it’s important to be aware of some of the things that could influence interest rates in the future.
5. Shop around
Last but not least, the easiest way to maximise your term deposit earnings is to shop around. Different ADIs offer different interest rates with some offering promotional rates for new customers (much like what you often see in the high-interest savings account market). Even outside of any special promotions, a quick look at a large cross-section of rates available in the market (for a 6 month term deposit with interest paid at the maturity of the term) revealed a more than 1.2% difference in raw advertised rate from the highest to the lowest interest rate on offer! This is a lot given that most term deposits are pricing under 3% p.a. Do your research and make sure you read the Product Disclosure Statement (PDS) before making any financial decisions.