- Term deposit definition
- Why invest in term deposits?
- Current term deposit rates
- What affects term deposit rates?
- Inflation & term deposits
What is a term deposit?
Term deposits are by definition a simple product: you deposit a stash of money in an account for a fixed period of time and earn a fixed rate of interest. At the end of the fixed period, you could either reinvest the money in the same or a different deposit, or you could cash out and, say, splash out your interest earnings on a beach holiday or something.
Why invest in term deposits?
One of the main reasons people invest in term deposits over other investment assets is for safety. Since the Banking Act 1945, deposits with authorised deposit-taking institutions (ADIs) have benefited from high levels of regulatory protection that minimise the risk of losses. This protection was greatly strengthened with the introduction of the government deposit guarantee in 2008, which made term deposits virtually risk-free.
Term deposits are essentially a guarantee that you’ll at least earn something on your investment. This makes it a popular investment option among elderly retirees, who often prefer a more conservative asset allocation to protect their hard-earned retirement dollars.
Another reason many investors favour term deposits is because of their simplicity: You deposit a lump sum of money with an ADI for a fixed interest rate over a set period of time (known as the term). At the end of the term (maturity), the deposit is paid back to you along with the interest it earned.
Current term deposit rates
As at January 2019, the average term deposit interest rate across all terms offered on the market for a $10,000 deposit is around 2.30% p.a, which is just 40 basis points above the inflation rate (1.90%). The graph below shows what the average rate is for each available term – these rates are generally higher for longer terms.
What affects term deposit rates?
The interest rates on term deposits are typically influenced by a range of internal and external factors.
- The official cash rate. The cash rate, presided over by the Reserve Bank of Australia (RBA), is perhaps the biggest influence on term deposit rates across the whole market. It is the rate commercial banks borrow and lend to each other at on an overnight basis, influencing the rates on consumer finance products including home loans, savings accounts and term deposits.
- Market competition. If one bank were to raise their term deposit interest rates higher than their competitors, they can attract more term deposit customers – gaining more funding. So when a major bank raises their term deposit interest rates, others often follow.
- Regulatory requirements. Australia’s 15 largest banks are required to rely on more stable sources of funding, such as term deposits. This comes from the Net Stable Funding Ratio (NSFR) requirements, released by APRA in late 2016. At the time this was implemented, major banks raised their long-term deposit rates to attract more of this type of funding. Future regulatory changes such as this can impact the rates offered by your term deposit provider.
- The investment term. Most providers will offer a host of different deposit terms, ranging in length from one month to a maximum of five years. The general rule of term deposits is the longer the term, the higher the interest rate.
- The amount invested. Although not too common, some term deposits give you a higher interest rate if you invest more than a specified minimum amount. Bear in mind that $250,000 is the maximum amount you’ll be covered for under the government deposit guarantee.
- The interest frequency. The average term deposit pays interest at maturity, which is when the term ends. This is the norm for term deposits with a term of one year or less. For longer term deposits, it’s not uncommon for them to pay interest into your account monthly, quarterly, semi-annually or yearly.
- Early withdrawals. The interest rate on your term deposit can be reduced if you decide to withdraw before the term ends.
Inflation & term deposits
Inflation is broadly defined as “the general increase in price and a fall in the purchasing power of money”. It’s a natural thing that occurs in growing economies, as more and more people buying things increases the prices of goods and services. Inflation is dependent on several key economic factors, such as wage growth, consumer confidence, an increase in supply and so on.
As at the September 2018 quarter, inflation is sitting just outside this target band at 1.9%. See how this rate has moved since September 2002 in the graph below.
How inflation affects returns on term deposits
If you had a one-year term deposit paying 2.00% p.a. By investing $10,000 with interest paid at maturity, you’d earn $200 in interest. However, after annual inflation of 1.9%, that 2.00% p.a. interest rate is worth just 0.10% p.a. This is known as your real rate of return – the initial interest rate minus the inflation rate. So after taking inflation into account, that $200 in interest would actually be worth just $10 in real terms.
How to beat inflation with savings?
Given today’s current low interest rates, term deposits are better for storing money away for a rainy day and practising good savings habits than they are for giving you strong returns that beat the inflation rate.
One of the best ways to get ahead over the medium to long-term is to include other asset classes in your investment (besides term deposits): shares, property, managed funds and bonds. These options carry a higher degree of risk than term deposits but have the possibility of much higher returns.
The ASX Long-Term Investing Report for 2018 shows that over the last 10 years, returns from the following asset classes have remained above the inflation rate:
|Asset class||Rate of return (p.a.)|
|Balanced managed funds||5.7%|
|Australian fixed income (aka bonds)||6.2%|
|Global fixed income||7.1%|