Term Deposits: What investors need to consider

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For investors looking to put their savings to use, and having the financial flexibility to commit to doing so over longer periods of time, placing funds in a term deposit may represent a viable investment option.

Certainly, when it comes to term deposits, there is no shortage of choice, with a wide range of options on offer from different financial institutions, variously geared to deliver different rates of return for different amounts invested over different time periods.

Given the amount of options on offer, it is worthwhile investigating all offers before committing to a term deposit and locking funds in to a potentially long-term agreement.

Whether a term deposit ultimately represents good value will, of course, depend upon a variety of circumstances, and will vary from one investor to the next, with investors needing to take into account a range of factors.

What is a term deposit?

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As outlined via the Cambridge Dictionary website, a term deposit is: “an arrangement with a bank in which you have an account that pays interest, usually with money left in it for a fixed period of time”.

This means that investors will need to commit to leaving a predetermined sum of money in an account over a set period of time, in turn earning the interest rate being offered by the financial institution.

Financial institutions then have this money at their disposal to make their own investments (for instance, lending to home buyers seeking home loans), in turn generating their own return on the money invested.

A number of factors influence how term deposit interest rates are set, ultimately governed by the push and pull of both local and global economic forces.

In New Zealand, the Reserve Bank of New Zealand manages monetary policy, with it setting the official cash rate, which is reviewed eight times per year, basing its decisions on wider economic health.

The official cash rate in turn impacts the interest rates set by financial institutions, from home loans to term deposits.

These different factors and the movement of the official cash rate, be it up or down, variously can make it more or less appealing to put money in a term deposit.

Are term deposits secure?

Term deposits represent a comparatively safe investment, however it should also be kept in mind that no investment is entirely risk-free, and, as with any investment, term deposits are subject to a range of factors.

It is worth noting that there is no deposit insurance in New Zealand, with the Reserve Bank policy, the Open Bank Resolution, “aimed at allowing a distressed bank to be kept open for business, while placing the cost of a bank failure primarily on the bank’s shareholders and creditors, rather than the taxpayer”.

With this in mind, the credit rating of a financial institution is a good place to start in terms of determining the sort of security that will be provided by a financial institution, providing a guide as to its financial health.

The Reserve Bank requires that: “All New Zealand-registered banks must obtain and maintain a credit rating applicable to their long-term senior unsecured obligations payable in New Zealand, in New Zealand dollars.”

Credit ratings must be published in registered banks’ quarterly disclosure statements, while information on credit ratings can also be found via the Reserve Bank website.

Who should be investing in a term deposit?

Term deposits may make sense for investors unconstrained by cash-flow issues, who are looking for a simple and comparatively low-risk investment option (which is how they are often promoted by financial institutions).

They also present a comparatively secure form of investment, being protected from market fluctuations, locking in a set interest rate (this, it should be kept in mind, works both ways – in the event the market either rises or falls).

Another factor that should be kept in mind, is that they present a low-maintenance investment option, providing for funds to be stored in an account, being hands-off in terms of accessing the money over the term of the investment.

Hands-on investors will, of course, consider the comparative benefits of the range of investment options at their disposal, weighing up risk versus reward, in assessing what the benefits of term deposits are as opposed to other investments.

How to choose a term deposit?

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Deciding which term deposit is the right one to commit to will depend upon a variety of factors, determined by individual circumstances.

Term deposit interest rates are determined by both the amount invested and the length of time for which it is invested, providing investors greater incentive to invest more and over longer periods of time.

While the rate of return will be greater for longer-term investments, investors should keep in mind that they will not be able to access their funds over a longer period of time (which may potentially preclude from participation in other investments).

Additionally, with the interest rate locked in over a set period of time, while a term deposit will provide protection from falling interest rates, interest rates may rise over the period of the term deposit.

In this regard, investors should assess the current state of the market and consider its likely short-term and long-term movements – which is, of course, easier said than done.

Financial institutions advertise their term deposit interest rates and minimum and maximum investment amounts via their respective websites, and it is worthwhile comparing the various rates on offer in the context of the length of the investment (term deposit periods may vary anywhere from 30 days to five years).

Investors will then need to determine what their optimal amount to invest will be and over what period of time in selecting a term deposit that will provide maximum return on investment.

What to be aware of?

There are a number of factors that investors should be aware of before investing in a term deposit, and it is worthwhile looking beyond the interest rate and the term of the investment at some of these other details.

When it comes to payment of interest, some term deposits will pay at maturity, which means that investors will need to wait until completion of the full term before receiving the return on their investment.

Alternatively, other term deposits may provide for monthly interest payments, potentially providing for a regular income stream over the term of the deposit, being paid into a separate nominated account.

Meanwhile, compound interest offered on term deposits provides for interest to be earned on interest, with the interest earned over set periods in turn added to the total of the term deposit, via which interest will be subsequently calculated at the next instalment.

Investors should also keep in mind the policies that apply to early withdrawal of funds from a term deposit, including notice periods that apply and a potential reduction in interest payable on the money withdrawn.

When it comes time that a term deposit is maturing, investors should reassess their options, be it sticking with the same term deposit or exploring other investment possibilities.

These factors should be kept in mind, and in choosing a term deposit, investors will need to consider not only the term deposits on offer, but also the conditions that apply to term deposits, along with other potential investment options.

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