If you’re looking for a top term deposit, the first thing to understand is what, exactly, a term deposit is.
A term deposit is an account that locks in your money for a specified period of time (the ‘term’) and at an agreed interest rate. You cannot access your money for the length of the term, unless you a penalty fee for early withdrawal.
At the end of the term, you can either roll over the money into another term or withdraw it, plus the added interest.
What types of top term deposits can I invest in?
Short term: Generally, this means less than a year. So maybe deposit your money for three, six or 12 months. Things to consider:
- With shorter terms, banks generally offer lower interest rates
- Useful if you want access to the money sooner
- Good for specific short-term savings goals
- Can be useful for taking advantage of changing interest rates because your money is not tied up for too long
Long term: More than 12 months, generally up to five years. Things to consider:
- Banks generally offer a better interest rate
- ‘Set and forget’ – let your money work for you in the background
- If you have the interest paid regularly back into the account, you will get interest on your interest (called ‘compound interest’) and build your investment faster
What makes a top term deposit?
The main sign of a top term deposit is that it pays a high interest rate. Shop around to find which account offers you the best rate for the amount you want to deposit and the term you want to deposit it for. Interest rates will vary, according to those factors, and will usually increase if you are prepared to deposit a larger amount.
Remember, though, to calculate the actual rate of return on your investment when you are negotiating an interest rate. To do this, you need to subtract the current inflation rate from the interest rate being paid on the term deposit, as well as any tax you have to pay on the interest. For example, if your term deposit pays 3 per cent and the inflation rate is 2 per cent, your actual rate of return would be 1 per cent before tax. Depending on your marginal tax rate, your ‘real’ rate of return could actually end up being negative!
Also, be careful about the interest rate if you are going to automatically roll over your money into another term deposit. Sometimes, a financial institution will roll it over at a different interest rate (usually the current one) than the one you may have agreed to for the first term. Shop around in case there is a better interest rate for your money somewhere else.
Also, as noted above, a top term deposit will probably pay interest regularly, rather than as a lump sum at the end. As an alternative to compounding your interest, you can also have the interest paid into a transaction account, if you prefer to have that extra bit of spending money each month.
Most financial institutions will charge you a penalty fee for withdrawing your money before the end of the term. However, an ‘advanced notice’ term deposit allows you to withdraw some of your money before the end, without being charged. For some people, this is an important feature in a top term deposit. If you think this might be useful for your situation, check how much notice you need to give in advance.
Always read the product disclosure statement (PDS) so you know all the details of the account you’re signing up for.
What are the pros of a term deposit?
- You can’t chip away at your money with frivolous spending
- A fixed interest rate means you have security about your investment
- You can ride out any fluctuations in the market because your interest rate is guaranteed
- Compound interest – your savings can grow even faster
What are the cons of a term deposit?
- You can’t add to your deposit until the term is finished
- You can’t touch your money until the end of the term (even if you need it) without paying a penalty fee
- If interest rates improve while your money is locked up, you won’t be able take advantage of the better rate
Another idea to consider is ‘laddering’ your investments. This means having more than one term deposit, each one having a different maturity date, rather than having all your money in one term deposit. Then, if rates rise, you’re not locking all your money away and you have some spare money to take advantage if better rates happen to come along.
Also, remember that each account containing $250,000 or less is guaranteed by the government under the Financial Claims Scheme. So if you have more than $250,000 to invest, laddering is another way to secure your investment, because each deposit will be guaranteed.