Deciding between Savings Accounts or Term Deposits
Monday, February 23, 2015
Can’t decide whether to open a high yielding savings account or a term deposit?
While both are popular investment vehicles for cash, offering relative stability and certainty when it comes to rates of return, your choice will depend on a number of factors including your individual needs, savings goals and the timeframe around them. Do you want to be able to access your money in the event of an emergency or quarantine it to steadily grow over the longer term?
In comparing the two, it is important to look beyond headline interest rates and consider the ‘real’ rate of return when fees, inflation and tax are taken into account.
What is a savings account?
Savings accounts typically offer higher rates of interest whereas everyday transaction accounts used to pay the bills typically offer no or very low interest. Savings accounts are designed to help you grow your wealth. Some may offer features like rewarding regular deposits (by offering higher interest), while discouraging withdrawals.
Higher interest savings accounts, including online savings accounts, offer minimal or no fees, which means you can access your money easily, enjoy higher interest rates than traditional accounts and you will also earn compound interest on your savings.
What is compound interest? Unlike simple interest, which is paid at the end of a specified term, with compound interest the interest earned is regularly added to the principal or original deposit, resulting in a larger amount each time the interest is calculated.
There is usually no minimum deposit amount required, so you may find it easier to start a savings account than a term deposit account.
Having a separate savings account will help you keep track of your savings and how far you have come towards meeting your goal. You can set up automatic transfers from your everyday transaction account into your savings account.
The fact that it is easier to access your funds (than, say a term deposit) can increase the temptation to spend.
If there is an attractive introductory or headline interest rate, it will only apply for a short time, after which the rate is likely to be much lower.
You are at the mercy of variable interest rates, great in a rising interest rate environment but not so good when interest rates are trending down. You may prefer the guaranteed interest rate offered by a term deposit.
What to look for:
- The interest rate and how often interest is calculated.
- If applicable, the length of the introductory interest rate period, and what is the interest rate that applies after the ‘honeymoon’ period?
- Whether any minimum or maximum account balances are required. Penalties can apply if your balance falls outside of these.
- Are there any account keeping fees?
- Are you rewarded for making regular or extra deposits and do you lose interest if you withdraw funds?
- Does the account need to be linked to a transaction account?
Read the product disclosure statement and make sure the financial institution is an Authorised Deposit-taking Institution (ADI) by checking with the Australian Prudential Regulation Authority (APRA)
What is a term deposit?
A term deposit is a type of savings product where you lock away an amount of money with a financial institution for a fixed period of time (the term) and receive a guaranteed rate of interest. Only Authorised Deposit-taking Institutions (ADIs) can offer term deposits.
They are safe and reliable. A term deposit provides certainty around the return you will receive. As soon as you choose the amount, the term and how interest is to be paid you will know the overall rate of return.
Your savings are locked away for the duration of the term you have chosen, anywhere from 1 month to 5 years – a great way to grow your wealth.
Interest rates are fixed so you are protected if rates drop during the term.
There is very little risk of losing your money as term deposits with an ADI, of up to $250,000 are protected by a government guarantee (note that this also applies to savings accounts).
They can be a good option if you have received an unexpected windfall, like a lump sum inheritance, until you are sure about how you want to invest it.
They are less flexible than other products like online savings accounts. Depending on the Terms & Conditions of the account, if you need to access your money before your deposit reaches maturity you may not be able to. Some term deposit accounts have waiting periods to access your funds prior to maturity, typically this is a period of 31 days.
You may also have to pay hefty early exit fees or sacrifice some of your interest.
Simple interest – unlike savings accounts where the interest compounds - term deposits earn simple interest and provide no capital growth.
A minimum deposit – around $1,000 – is usually required. Higher interest rates may only apply to longer terms and/or larger deposits.
You won’t benefit should interest rates go up as your savings will be locked in at the lower rate.
Automatic renewal – you may elect to have your savings roll over into a new term deposit at maturity but this may be at a much lower interest rate – especially in the current low interest rate environment.
What to look for:
- Term deposits work best for longer term investments i.e. if you have a lump sum that you won’t need to use for a number of years.
- Check the early exit penalty and conditions – if you think you may need to use the funds before the term deposit matures, consider putting it in a high yielding savings account instead.
- The low current low interest rate environment is not great for cash investments so make sure you do your research when comparing products on offer. Look beyond the headline interest rate when comparing yields and shop around for the best rate for the period that suits you. Try comparison websites like RateCity, InfoChoice and Canstar.
If you've taken out a term deposit, don’t forget about it! You may find it has been automatically rolled over at maturity into a new term deposit at a lower interest rate – especially in the current environment which has seen rates on six month and one year term deposits slashed to under 3 per cent by some banks. Check the Terms & Conditions for the account to see if it has a grace period after the term deposit has automatically rolled over, which might allow you to change your mind without penalty.