The pros and cons of term deposits

What is a term deposit?

A term deposit is a type of savings account provided by a financial institution 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 (often called terms) and the interest rate typically varies depending how long your money is locked away for. Like any savings account, the interest you are paid is based on the balance in your account. There are generally restrictions on when and how you can access the funds if you need them before the end of the term and penalties which can apply if you withdraw your money early.

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Benefits of term deposits

Some of the benefits of term deposits can include:

• The certainty of having a fixed return on your investment, even if the interest rates on offer decrease during the term.

• They generally come with low set-up and ongoing fees.

• Locking your money away can help remove the temptation to spend it.

• Term deposits can be a useful way to save if you are planning to buy something down the track (not immediately). Say you want to buy a car, but don’t need it for several months. If you already have a deposit saved, you could put that money into a term deposit to earn interest while you wait.

• Term deposits can be low risk compared to other investment options, as long as they are held with an authorised deposit-taking institution (ADI), which are guaranteed up to $250,000 per account holder and per financial institution by the Australian Government.

Bede Cronin, Head of Product at Rabobank Australia, 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 low or no set up fees and you can generally open one with a 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,” Mr. Cronin 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.

Mr. Cronin 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 at a fixed interest rate,” he said.

Are term deposits risky?

Term deposits are generally considered safe, relative to many other forms of investment like shares and property, because you are guaranteed to get your initial deposit back, plus whatever interest you have earned.

However, locking your money away at a relatively low rate of interest for an extended period can mean you run the risk of the value of your money diminishing due to inflation. This can happen if inflation goes up at a higher rate than your interest rate. According to the Australian Investors Association (AIA), this is known as ‘inflationary risk.’

For example, if you put $10,000 in a two-year term deposit at 4.5%, but inflation over those two years stays around 5%, even though you would come out with more money than you started with at the end of the term, that money will be worth 0.5% less than two years ago. This is usually reflected in the increasing cost of goods and services, often measured by the Consumer Price Index (CPI). If the cost of goods and services has increased by 5% over those two years, then your money won’t go as far as it did two years prior.

Another potential risk with term deposits is 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.

Mr. Cronin notes that 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 financial goals. Weighing up the pros and cons of term deposits may help you decide if one is right for you. You can also compare different term deposits using Canstar’s comparison table.

“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,” Mr. Cronin 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 savings account so that you have access to some funds when you need them.

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“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 professional financial advice before making any major decisions about how to invest your money.

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