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» Articles - Certainty is the name of the investment game
Certainty is the name of the investment game
In the past 18 months, term deposits have made an indelible impression on those investors seeking certainty.
Now, as term deposits climb over a guaranteed six per cent over three-year periods, many investors are embracing the concept of reward with less risk.
According to the 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 per cent of their portfolios were re-invested 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 per cent from June 2007 to September 2008, making term deposits the most widely held investment by Australian investors.
Why investors have turned to term deposits
Term deposit investors typically want simplicity, safety, security and certainty in their investment return, and would like to ensure protection of their capital. However, they also want to earn a better return than generally available in cash, and are prepared to have their investment locked up for longer terms.
Investors generally like the idea of term deposits because they know they will get their money back at maturity, and the return is guaranteed. 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 ADI are guaranteed by the Commonwealth Government for amounts up to $1,000,000 under the Financial Claims Scheme (the Australian Government Guarantee).
Most ADIs offer investors a range of investment terms and interest payment options from one month to five years. So, if you are thinking of locking away a deposit for one year or more, but still require 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. Frequency of interest payments can also have a significant impact on compound savings, assuming that these amounts are rolled over and the nominal rates are the same See an example of interest payment options here.
Take advantage of higher long term rates
With the Official Cash Rate currently set at 3 per cent by the Reserve Bank of Australia (RBA), term deposits can present an attractive alternative to cash.
According to InfoChoice.com.au, effective 30 July 2009, for investment amounts of $10,000 or more, investors can earn up to 7 per cent for five years, 6 per cent for three years, 4.5 per cent for one year, 4 per cent for six months and 3.2 per cent for one month on term deposits paying interest at maturity.
How much should you invest?
Most investors typically invest in term deposits as part of their short-term cash allocation. However, term deposits are increasingly being allocated to as part of the Australian fixed income portion of portfolios as investors increasingly look for diversification, and want investments that can help reduce volatility, protect capital and also generate income.
As an income producing asset, investors may also consider shifting their allocations away from mortgage funds to term deposits.
A typical conservative investment portfolio with a 50/50 split between growth and defensive assets will allocate up to 28 per cent of the total portfolio to cash and Australian fixed income.
For a portfolio of $100,000, roughly $12,000 would be allocated to cash and $16,000 allocated to Australian fixed income. However, many investors are relying on the income-producing nature of these investments to offset the volatility of growth assets, such as equities.
Cash versus fixed interest
Some financial planners allocated more to cash and term deposits during 2008 than they did to equities. In fact, the investment platforms used by financial planners raised billions in term deposits last year, and the Commonwealth Bank of Australia's Avanteos platform claim that they received more than 50 per cent of their new net inflows in term deposits alone.
Inspired by better returns, investors are moving away from typical fixed income investments to term deposits. One asset that has been affected by the growing popularity of term deposits is mortgage funds. Used as a proxy for cash, these assets have become unpopular, with many mortgage funds now closed due to the dislocation in the credit markets, the near eradication of securitisation and a lack of liquidity, preventing investors from being able to get their money out.
What to do next: Learn more about term deposits.
For more information, or to discuss your specific situation, please contact me directly.
Tim Hewson
Investment Manager - RaboPlus
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