Are term deposits the new cash? During the global financial crisis (GFC) and now in this tentative post-GFC period, as the market crashed to crumbled around investors’ heads and high yields turned into high losses on investment, investors were and continue to look for a low-risk, low-yield investment option.

There’s nothing like a market crash and fears about foreign debt levels to send investors fleeing.

2010 has seen somewhat of a battle between the banks, tying to secure term deposit business with higher and higher interest rates, especially on long term deposits. So, for those looking for a somewhat safer investment than playing the stock market, term deposits may just be the way to go.

What is a term deposit?

Basically, a term deposit is a product offered by a financial institution which acts like a savings account. The difference being, that term deposits are set for a particular amount of time, and so is the interest rate.

The term for which your money is put away is fixed, and the rate of return is fixed regardless of market conditions.

What’s so good about them?

Term deposits are very attractive to the investor who hopes to make a modest return for a modest risk.

For example, I can put $30,000 into a term deposit account for an agreed period of 5 years at an agreed rate of 6%. Given that I didn’t touch that money for the agreed 5 years, I would make $10,147 on top of my initial investment at the end of the term if the interest was paid out annually, and $10,466 if the interest was paid out monthly. If you agree to put the interest back into the fund, the yield when the deposit matures can give you an even greater return.

The government will also now cover your investment through the deposit guarantee scheme. So, just in case the financial institution you have your deposit with falls over with a crash, your money is safe. There are a couple of caveats though.

Beware the traps!

The Australian government deposit guarantee scheme may not be around forever and largely depends on market conditions. It was brought in during the height of the GFC, when banks and large investment bodies were collapsing worldwide. When the good times roll again, the government may look at rescinding the scheme. The scheme also only covers a certain list of lenders which you can find here, so just check if your lender is on this list.

There are definitely some things you should take into consideration before deciding to undertake a term deposit.

Firstly, are you likely to need your money in a short amount of time? Many people can get into a trap of putting a large amount of saving into a term deposit, only to find that their rainy day has come well before the term of the deposit has run. Usually, you can get your money back, but fees are charged for the inconvenience. Fees which, if you withdraw your money within a short time frame, can end up eating the returns you got in the first instance.

Secondly, the banks can be a bit unforgiving when it comes to rolling over your investment at the end of the term. Basically, the bank or financial institution will write to you outlining your options before your term ends. In most cases, if you choose to do nothing, the deposit will reset into a ‘new’ term deposit identical to your first investment.

Here’s the catch though.

The rate of return for it will be much lower than your first term. If you don’t pick up on this before it’s too late and your deposit is rolled over, there are two outcomes: The first is that your deposit is stuck in a low-return investment option, and secondly, if you choose to switch your deposit too late, you’ll be charged exit fees.

There’s also the old chestnut about the low-yield nature of term deposits. Although term deposits can be high compared to regular savings accounts, other investment options will generally give you a higher return at a higher risk. For example, a term deposit will give you a fairly modest return but an investment in stock can give you higher returns if you invest wisely, especially if you’re a long-term investor. For example, since 1985, the all-ordinaries index has gone up from 712 points to 4,400 points. That’s about 617% growth, despite the post-tech crash and GFC.

The downside being that markets can be very, very volatile at times. It’s all about the amount of risk your willing to take, and in the investment world, the higher the risk the higher the return (more often than not).

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