It is now a question of when rather than if as regards rises in interest rates and that means investors looking at locking away their money in a term deposit, also known as a fixed term or certificate of deposit, need to rethink their strategy.
Term deposits can work well for investors who want to park funds for a set term and get a guaranteed rate of interest. The returns on other forms of investment might be higher, but term deposits are hard to beat for safety and offer a better interest rate than day-to-day savings accounts.
Banks will usually offer higher interest on longer terms, although the table below shows that is not always the case, and sometimes the higher return is so minimal it is better to take a six-month or one-year term and be ready to switch into a better rate when interest rates rise. That should be the case now, but the table below shows that some term deposits already have a fat margin above central bank reference rates.
Normally, investors would take up short-term deposits when they believe interest rates are rising, but the global economic situation complicates the picture. Although rate rises are forecast next year, they might be minimal because central banks do not want to strangle the first moves towards recovery. If official interest rates rise only a few percentage points, investors might still be better off in a longer-term deposit.
Average term deposit (per cent) Central bank rates
6 months 1 year 2 year 5 year
United States 1.33% 1.71% 2.25% 2.90% 0.25%
United Kingdom 1.60% 3.00% 3.75% 5.10% 0.50%
Singapore 0.25% 0.45% 0.70% 0.25%
Hong Kong 0.10% 0.20% 1.50%
India 5.50% 6.00% 6.00% 6.00% 5.00%
Australia 4.50% 5.00% 5.50% 3.25%
Canada 0.20% 0.50% 0.75% 2.25% 0.25%
European Central Bank 1.00%
* these are effective annual rates
Sources: bank websites, central bank websites, www.fxstreet.com
Interest rates for certificates of deposit in the United States fell to record lows this month as the Federal Reserve kept rates low to stimulate the economy. Many US economists believe rates will stay low for a while, which makes CDs at current rates very attractive, even for the longer term.
The same goes for the UK. Neither the European Central Bank nor the Bank of England have been in a hurry to raise rates, although UK economists are forecasting rate increases there in the first half of next year. Australian interest rates rose this month but there is plenty of debate about when the Reserve Bank of Australia will – or should – move again, which means the picture on term deposits is far from clear.
Banks can be very competitive on the rates they offer and the internet has made it easier to shop around, with a number of websites doing the legwork for you in finding the best rates and providing calculators so you can compare returns. It’s wise to remember that not all rates are the same, you might get a higher interest rate on a bigger amount of cash, interest payment periods differ and sometimes banks offer special short term deals if they need to attract deposits to top up their own requirements for cash.
There can also be heavy fees on breaking a term deposit, because the bank is expecting to have the use of your money for the term. Term deposits are most suited to people who know they won’t need the money for that period. If you want the higher interest rate of a term deposit but worry you might need some cash in the meantime, it might be better to split the deposit, say into a three-month term – that can always be rolled over – and a longer term one that you are sure you won’t need. Try to stagger the terms so they don’t all mature at once unless you don’t care when the interest arrives. However, while rates are low it might be worth putting your money away for five years rather than taking a much lower rate on a shorter term.
Also make a note of when the deposit is maturing so you can decide ahead of time whether to roll it over, otherwise the bank might automatically do it for you.