Three things you should know about your bank term deposit
Kiwi households have over $160 billion invested in term deposits issued by financial institutions, such as banks. This has doubled in amount from just 10 years ago.
Suffice to say term deposits are a popular means of investment for Kiwis!
It’s relatively easy to sign up to a term deposit. You can shop for the best term deposit rate on any given day and fill out some basic details about yourself, transfer money into it and you are set. As much as it might appear to be a straight forward investment, there are still some very important points you should consider when investing in term deposits.
Term deposits are different to your savings account
Both your savings and term deposit accounts are investments held in the form of cash. But, while the cash in your savings account can be withdrawn at any time, your term deposit will typically have a set number of days (called maturity period), before which you can withdraw – this could be 30 days, 90 days, 180 days or any period specified by the bank.
For giving up the ability to withdraw at any time, your term deposit will pay you back more than it would in your savings account. Current term deposit rates vary between 0.5% and 4.2%. Variation in these rates will depend on not only which maturity period you have chosen, but also on which bank you decide to invest with.
You should be aware that there is a lot of merit in shopping around. For example, currently if you decide to invest $10,000 in a 5 year term deposit you could earn anywhere between $2,100 and $1,925 depending on the bank. Shop around!
What happens when your term deposit matures?
At maturity, or when you get to the end of the term you signed up for, you can either choose to reinvest the amount into another term deposit or withdraw your entire balance and invest elsewhere.
Term deposits are not set and forget investments. At maturity it’s a great time to consider whether your personal circumstances have changed or if events occuring in the world mean that you may be earning more from other investments.
The one downside to a term deposit is that your money is tied up for a pre-determined time and if you were to request a withdrawal during the term the bank will put a penalty on you by reducing the interest they pay you. That is a cost to you. So, before you commit to a longer term determine whether you might need to get your hands on that money before the end of the term or not.
Don’t get sold on headline term deposit rates
Term deposits by its very nature are more secure than other investments such as shares. The way term deposits work is that the cash you invest in one is pooled together with those from other term deposit investors, and put to use by the bank to lend to others. The bank then promises a fixed return (interest rate) on your money over the term to maturity. As such, not only do you enjoy a stable ongoing stream of returns but also the prospect of the original amount you put in at the end of the term.
The headline interest rate determines how much your regular payout will be. But, remember because this is an income that you are earning, this amount will be taxed. So the actual amout of money you are left with will be less than what the headline rate implies.
This is different to other investments such as your KiwiSaver fund, returns from which are already taxed within the Fund.
So, if you are comparing term deposit rates with returns from other investments, remember to adjust for your tax rates to make a meaningful comparison.