Certainty in uncertain times

There are very few certainties in life and when it comes to investing, there are even fewer guarantees. So it’s no wonder that the humble term deposit is making a comeback as it offers investors a guaranteed return for a fixed term.

According to the 2009 Merrill Lynch Global Wealth Management and Capgemni’s annual world wealth report, one in four high net worth investors withdrew assets from financial planners last year and up to 50% of their portfolios were reinvested into cash and term deposits.

The Australian Securities and Investments Commission (ASIC) estimated that term deposits invested in an Authorised Deposit-taking Institution (ADI) grew by more than 39% from June 2007 to September 2008 making term deposits the most widely held investment by Australian investors.

Why turn to term deposits?

Term deposit investors typically want simplicity, safety, security and certainty of their investment return, would like to ensure that their capital is protected, want to earn a better return than is generally available on cash and are prepared to have their investment locked up for their chosen term.

For many, term deposits are also a great way to protect their cash against the rising tide of inflation and also generate regular income.

Term deposits from an Authorised Deposit-taking Institution, (ADI) are guaranteed for free by the Commonwealth Government for amounts up to $1,000,000 under the Financial Claims Scheme up until 12 October 2012. So for term deposits with maturity dates beyond this it’s also worth considering the institution’s credit rating as it often indicates its level of safety.

Most ADIs offer investors a range of investment terms and interest payment options from 1 month to 5 years. And if you are thinking of locking away a deposit for one year or more, but still require some liquidity, you can continue to draw an income from term deposits by selecting a term with monthly, quarterly, semi-annual or annual interest payments. This not only provides you with an income stream, but also allows you to invest further out along the yield curve to pick up a higher interest rate.

Most investors typically invest in term deposits as part of their short-term cash allocation. However, as investors look for more diversification and investments that can help reduce volatility, term deposits are increasingly being allocated to as part of the Australian fixed income portion of portfolios. Term deposits can also help protect capital and generate income as they allow you to tailor your investments to meet future liquidity needs.

Go for longer

With the OCR currently set at 3% by the Reserve Bank of Australia (RBA), term deposits can present an attractive alternative to cash.

According to InfoChoice.com.au, for investment amounts of $10,000 or more, investors can earn up to 6.00% for three years and 6.5% for five years, compared to 3.80% on a one month deposit, 4.51% on a  six month deposit, 4.61% for one year.

How much to invest

A typical conservative investment portfolio with a 50/50 split between growth and defensive assets will allocate up to 28%of the total portfolio to cash and Australian fixed income. For a $100,000 portfolio, roughly $12,000 should be allocated to cash and $16,000 to Australian fixed income. However investors are typically making higher allocations in order to protect capital and generate income, to offset the volatility of growth assets like equities.

How to select the right term deposit

Make sure you choose the right term. Review your need for liquidity to ensure that you do not need to break the term deposit early. Alternatively, invest a smaller amount or invest for a shorter term.

Check the terms and conditions. Make sure you are familiar with the conditions of the investment and also understand whether any early termination fees are payable and how much it might cost.

Understand how interest is calculated. Plan your cash flows and understand your future need for cash and liquidity. Make sure that the interest payment options you select are appropriate.

Check the credit rating of the ADI offering the term deposit.  Make sure you are comfortable with the institution you are investing in.