Banking on deposits still suits some investors

Five-year term deposits is not a strategy for everyone, or an entire fund, but has its merits.

Summary: A low interest rate environment will put many off term deposits, but for some investors, if the money is not needed for five years, a rolling term deposit strategy is worth considering, especially while the government guarantee for deposits below $250,000 is still available. But shopping around for the best rate is vital.
Key take-out: Homework is the key to finding the best long-term deposit rates.
Key beneficiaries: General investors. Category: Income.

This week I want to talk about term deposits. It is a subject most self-managed fund and private investors almost want to forget because the rates are now so low, and look like falling further. But a fixed portion of one of my funds has a five-year term deposit strategy and last week I secured 5% deposit money, government-guaranteed. The opportunity is still there for those interested in such a strategy, but it’s not for everyone.

The idea is that every year the same amount of money will be invested in five-year term deposits at the best possible rate. And in five years you will then have a rolling set of maturing deposits which can either be invested again for five years (or shorter-term) or used to pay benefits. 

I must emphasise that with five-year deposits you can look foolish if interest rates rise and you must be certain you will not need the money over the five years. Accordingly is not a strategy for everyone and it is not usually a strategy for all of a fund. But it happens to suit me in a certain area because the money will not be needed for five years and once in place the roll over each year works to lower risk.

Shopping around

Last year, around July I looked through the market for five-year deposits and the best I could find was the Rabo Bank at 5.7%. I was happy that Rabo was a sound European bank and I made some enquiries along those lines and was well satisfied. Of course I also got the government guarantee because the amount invested was less than $250,000.

But I am reluctant to be totally reliant on the guarantee – I am looking for a sound bank deposit decision at the same time. So this year I went out into the market again to have a look around at what was available with the help of the CanStar website. And I found that there were five-year bank deposits available at 5%. When I looked at the majors, the rates being offered for five years were horrifying. For example the Commonwealth Bank was offering only 4.4% Westpac was offering 4.55% NAB and ANZ were both at 4.5%. But a number of banks were offering 5% and somehow – perhaps it has no logic – I like to have a five in front of the rate for long-term bank deposits. 

There were a number I could have chosen, including Suncorp offering 5% and Bank Vic at 4.75% was not far behind. But I chose Investec. Now the first thing you will say to me is that I have been watching the Test and Investec got the most incredible plug as the sponsor of the English team. (I feel a little sorry for the CBA bank, the Australian team’s sponsors.) It’s true that because of the Test plug, when Investec came up at 5% I checked them out first and discovered that they were a bank that had not been bailed out in the GFC, they have a major operation in Australia lending to doctors and medical practices in the health industry and of course the Australian operations are regulated by APRA. Investec’s home town is in South Africa but its UK bank, like Australia, a separate entity. I felt content that although rates have fallen very substantially in the last twelve months, I was still getting 5%. Unfortunately this morning  Investec lowered its five-year rate to 4.94%. Why didn’t I pick Suncorp?  Probably illogically. I suspect that the Test promotion has an effect.   Suncorp is a sound bank and of course it is government guaranteed for deposits up to $250,000.It is still offering 5%.   

In terms of actually making investments in these institutions it is possible to do it on line and most people do that but I am old-fashioned and I like to see where it is that the money has gone. And so I walked into the Investec’s Melbourne office without any warning and there was a little surprise as I don’t think Investec get many people walking in to the office wanting to invest in deposits. But they were able to handle it very efficiently. 

In terms of actually making investments in these institutions it is possible to do it on line and most people do that but I am old-fashioned and I like to see where it is that the money has gone. And so I walked into the Investec’s Melbourne office without any warning and there was a little surprise as I don’t think Investec get many people walking in to the office wanting to invest in deposits. But they were able to handle it very efficiently. 

And here is a message all Eureka readers wanting to invest in bank deposits should heed. Whether you are talking about five-year deposits or one-year deposits or anything in between do not simply go to the bank where your transaction account resides. This particularly applies to the Commonwealth Bank whose published rates are often a notch below the other majors. The difference between a 4.5% and a 5% rate is in fact over 10% as a proportion -- and that is a substantial amount. Because of the government guarantee, it is possible to invest in smaller organisations and get a government-backed security. But you must shop around. In the one-year space, as I have said many times, (although their rates have come back substantially) NAB’s UBank remains at the top of the list. But I do urge you to shop around.

Unfortunately I think we are going to see more interest rate reductions but there will come a time when interest rates will rise, probably triggered by a falling Australian dollar or a serious European crisis. Meanwhile I believe the Reserve Bank is wrong in thinking that interest rate reductions at these low levels deliver any significant boost to the economy. The lower rates go the more nervous people become and really it is an income transfer from savers to borrowers. And the borrowers tend to simply increase their repayments rather than spend the money.

Low rates to push house prices higher

Having said that, as I have written before, I am of the view that these very low interest rates are going to promote a bounce in dwelling prices starting in Sydney but spreading to other eastern states and that will become particularly evident if Tony Abbott wins the next election. And assuming it is a clear win, the confidence boost confidence to go right around the economy. But there is no certainty he is going to win. Rudd is a much better campaigner and will make it very tough for Tony Abbott because Abbott has not established a vision for Australia with the Australian population. That is something he should have done months ago. Instead he concentrated all his efforts in removing Julia Gillard which was, as it turned out, was the wrong strategy. He would have been better to have gone easy on her and promoted his vision for Australia. That way he might now be fighting Julia Gillard rather than the much more aggressive Kevin Rudd.

Meanwhile as interest rates fall, bank term deposits will become less and less attractive to self-managed superannuation funds and private investors because the looming tax rate hike takes them down even further from today’s low levels. But as I have shown it is still possible to run a 5% minimum interest rate rolling five-year strategy.