The pros and cons of Term Deposits

Unlike some other types of investments, term deposits rarely make news headlines or spark debate in online discussion boards, but they can be popular among investors looking for a predictable return on their savings. We explore some of the pros and cons to consider.

But first…

What is a term deposit?

A term deposit is a type of bank account that allows you to lock away cash for a set period of time at a set interest rate. Term deposits come with various duration options, or terms, and the interest rate typically varies depending on how long your money is locked away for. There are generally strict restrictions on when and how you can access the funds if you need them before the end of the term, and an early withdrawal fee can apply if you withdraw your money early.

Advantages of term deposits

Advantages of term deposits can include:

• The certainty of having a fixed return on your investment, even if interest rates decrease during the term.
• They generally come with no set-up and ongoing fees.
• Locking your money away can help remove the temptation to spend it.
• Term deposits can be low risk compared to other investment options. Term deposits held with authorised deposit-taking institutions are guaranteed up to $250,000 per account holder and per financial institution by the Australian Government.

Bede Cronin, Head of Rabobank Online Savings, told Canstar that term deposits can be suitable when you know you won’t need access to your savings for a set amount of time.

“They provide peace of mind, allowing you to invest for longer periods – usually up to five years with a fixed interest rate – so you know exactly the return you’ll get during the investment term. The return won’t be impacted if market rates fall; however, your rate will also not increase in line with the market,” he said.

“Term deposits are also a simple product to understand, they typically have no set up and ongoing fees and you can generally open one with as little as $1,000, depending on the provider."

“Banks generally offer a variety of terms, ranging from one month to five years, so you can choose a term to suit your needs, and because the funds are safely locked away, it can be a great way to curb impulse spending,” Bede said.

Disadvantages of term deposits

Disadvantages of term deposits can include:

• Being restricted in how you can access your money if you need it.
• Potentially lower returns compared to other types of investments.
• You usually cannot make additional deposits once the term deposit is established.

Bede said the restrictions that come with term deposits can mean they are not suitable for some people and situations.

“A term deposit may not be the best choice when you need flexibility or quick access to your savings; for example, if you are actively looking to purchase a home or another big ticket item such as a car, boat or investment property.”

“Because the savings are locked away for the duration of the term selected, you will not benefit in an environment where interest rates may increase as your funds will be locked in with a fixed interest rate,” he said.

Are term deposits risky?

Term deposits are generally considered safe, relative to many other forms of investment, because the first $250,000 of your investment is protected by the government under the Financial Claims Scheme (FCS). Be mindful that by locking in a fixed rate on your funds for an extended period of time may increase the risk of the purchasing power of your money diminishing over time, due to prices going up at a higher rate than your interest rate. According to the Australian Investors Association, this is known as ‘inflationary risk.’

Another potential risk with term deposits is that when the initial term comes to an end, you could be automatically rolled into a new term, potentially at a lower interest rate than your initial term. Depending on the circumstances, you could then be penalised if you decide to withdraw your funds after the rollover term has commenced.

According to Bede, savers should plan ahead for when the term ends.

“It’s always important to be aware of what is happening with your money,” he said. “Set a reminder for when your term deposit is due to mature or rollover. Also remember that if your term deposit automatically rolls over you have a grace period, usually ranging from seven to 14 days, after the term deposit matures to withdraw your funds or reinvest for a different term without penalty.”

Are term deposits worth it?

Overall, whether a term deposit is a good option for you will depend on your circumstances and goals.

“Only open a term deposit if you are certain you won’t need that money for the period selected, as early withdrawal fees may apply if you need to withdraw your funds before the maturity date,” Bede said.

“Also take into account your personal circumstances and how much flexibility you need with your money, as there are other types of savings accounts that could be more suitable. You might also consider locking some of your funds away into a term deposit and keeping some funds in an at-call saving account so that you have access to some funds when you need them."

“Lastly, if you ever find yourself in financial hardship it’s important to know that you can request immediate access to your funds without being charged any early withdrawal fees or penalties.”

If you need help, it may be beneficial to get financial advice before making any major decisions about how to invest your money.

Our Head of Online Savings recently spoke to Canstar Deputy Editor Sean Callery about some of the pros and cons of keeping your savings in a term deposit. This article was originally published on Canstar.