Term Deposits: A Wise Investment During These Times?
With the economic impacts of Covid-19 being felt around the world, term deposits may be a great investment option. As with previous economic recessions, stock markets across the world have become highly unstable due to the lockdown the whole world is facing right now. Luckily, there are alternative investment classes where you can place your money and reap consistent and predictable returns, with a popular one amongst Kiwis being a term deposit.
What are Term Deposits?
To appreciate why term deposits might be the best investment option right now, we need to understand how bank deposits work. When you deposit a sum of money, say $5,000, into a bank account, the bank uses that money for their own purposes, for example, lending it to another customer or investing it in stocks. You are, however, free to withdraw your money at any time, and the bank will pay you interest for using your money for their own purposes. The issue with this model is that banks don’t know when you’ll withdraw your money and hence they cannot decide how much money they can lend and for how long. That’s where term deposits come into play.
In term deposits, you deposit your money for a specific period of time – this can range from one month, all the way to 5 years. In return for committing your money to the deposit for the fixed period of time, term deposits will generally offer higher interest rates than normal savings accounts. Regardless of what investments the bank makes using your money, you are guaranteed the interest rate which you agreed to when you took out your term deposit.
For investors who may be spooked by what’s happening in the stock markets right now, or who just want to diversify their portfolio to include some lower risk investments, term deposits are a great investment option. Other reasons that make term deposits attractive are:
- Guaranteed interest rate, better than a normal savings account
- Low possibility of loss
- Predictable returns and cash flow
- Interest can be compounded (depending on when it is paid).
How much can I typically earn?
The rate of return on term deposits depends mainly on the duration of your deposit, and the amount deposited. Current term deposit rates offered by banks in New Zealand range from 0.35% for 1 month term deposits, to 2.4% for 5 year term deposits. As with most financial products, it pays to shop around to ensure you’re getting the best bang for your buck with your term deposit – remember to compare term deposit rates before making your decision!
At the time of writing, Heartland Bank is offering 2.65% on a 10-month term deposit, which is one of the leading rates around.
What are the disadvantages of term deposits?
A term deposit locks in funds for a fixed period of time, although usually at a higher interest rate than online, call or savings accounts. Banks do not legally have to allow customers to break term deposits, that is, return the money early. Whether you can break your deposit will depend on the terms of your contract with the bank. In most cases, you can do so only if the bank agrees.
- Some banks offer a cooling-off period, during which you can cancel your term deposit and get back your principal without interest. Some banks require a certain period of notice before letting you break your term deposit (although proving hardship may avoid such notice).
- If the bank agrees to break your term deposit, it will probably reduce the interest rate on the funds you’re withdrawing. It may also seek to recover interest that was paid at the higher rate while it had the money.
During these uncertain times, term deposits may offer a more predictable and less volatile investment option for those looking for a safe place to park their money. If you think If there is a chance you may need the money before the term expires, consider a shorter term. It’s also a good idea to read the relevant terms and conditions carefully, especially around cooling-off periods, or what you may need to do to break your deposit, should the need arise.
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