HAVE you been stuck with low-interest term deposits ever since November 2011?
That’s when the Reserve Bank cut the cash rate from 4.75 per cent to 4.5 per cent and kept cutting until November 2020 when it ended up one-tenth of a percent. That’s where it sat until May this year.
Term deposit rates have traditionally always been higher than the Reserve’s cash rate, even when the cash rate was 0.1 per cent. A ridiculously low term deposit rate of a quarter per cent went with that.
You can take the glass-half-full approach and say that the 0.25 per cent term deposit rate was two-and-a-half times the 0.1 cash rate, where it more normally is one-and-a half times the cash rate.
But that would be taking the glass-half-full crazy approach.
Still, a positive lesson can be drawn from the now decade-long-and-continuing term deposit fiasco.
That lesson is: when interest rates are lower than inflation, there are alternatives to term deposits. We’ll look at a simple alternative.
Many people believe that term deposits represent a risk-free investment, but they are anything but.
Yes, you put, say, $10,000 in a 12-month term deposit, and you get $10,000 back plus $25 in interest. But with inflation of, for example, 3 per cent, you are actually $275 in purchasing power worse off when the thing matures.
And that’s $275 you’ll never see again.
Drumroll: our alternative.
Australian Exchange Traded funds, commonly referred to as ETFs are investment funds that buy shares. They are called ‘exchange-traded’ because ETFs themselves are companies listed on a stock exchange.
If you buy shares in an ETF, you indirectly own the same shares the ETF owns. Except, you don’t have to do the picking of those stock, because professionals at the ETF do that.
So, if you buy, say, $10,000 worth of shares in an ETF invested in good-dividend-paying companies (think banks, utilities etc), your dividend income will be greater than term deposit interest.
Also, over time the value of your shares will keep pace with inflation.
Mind you, we’re not saying that everybody needs to go out and do this. This is just general financial information, showing an alternative to term deposits.
A second mind-you, there are also ETFs which offer ‘risky’ investment options, which you may want to avoid.
Apart from ETFs but closely related, there are Listed Investment Companies, or LICs, pronounced ‘licks’.
The difference is that an ETF will tell you exactly what they are invested in.
A LIC can be quite vague about where they will invest, although they will generally tell you about their investment philosophy.
Again, there are LICs which take bigger investment risks, which you may want to avoid.
Some of the most popular ETFs include Vanguard’s Australian Shares ETF, iShares S&P 500 ETF, and BetaShares Australian Government Bond ETF.
Among the best-known LICs are Plato Income Maximiser, Argo and Australian Foundation Investment Company.
This article is general in nature and is not intended to influence readers’ decisions about investing or financial products. Investors should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.