Term deposit investors have had it pretty good in recent years, but that’s changing quickly and many savers are on borrowed time.
Interest rates are headed lower, and those sitting comfortably on the sidelines should prepare for that.
If they take too long, they’ll not only miss opportunities elsewhere but they’ll be facing a hefty fall in income.
A six-month term deposit was offering a yield of six per cent in July, the highest level since 2008.
That made it much easier to earn a steady, reliable income from your savings.
However, term deposit rates follow the Official Cash Rate (OCR), which means they’re down sharply and there are more declines to come.
The OCR has fallen from a 15-year high of 5.50 per cent last year to 3.75 per cent today.
The Reserve Bank, as well as financial markets and economists, expects another two or three cuts from here.
That’ll be a function of how strongly the economy rebounds, and where inflation goes from here.
The annual inflation rate is within the Reserve Bank’s target band of 1-3 per cent, and while there are some unders and overs the job is essentially done.
That means the Reserve Bank has the luxury of returning its policy rate to “neutral”, which is the steady-state level where it’s not trying to speed things up or slow things down.
It’s hard to pinpoint exactly where that is, but it’s estimated to be between 2.5 and 3.5 per cent.
Let’s just call it three per cent, and assume that’s where the OCR is headed.
While this is fantastic news for highly indebted borrowers, it’s not so good for many conservative savers and income-focused investors.
Anyone relaxing in term deposits is facing further declines in their income stream during the months ahead.
Over the last 15 years, whenever the OCR has been at three per cent or more the six-month term deposit rate has been, on average, 0.65 per cent above that.
The six-month term deposit rate has slumped to 4.4 per cent today, and it looks set to fall into the threes over the coming months.
The Official Cash Rate (OCR) and the six-month term deposit rate (%)
Depositors have seen a 25 per cent plus hit to their income stream since the middle of last year, and they could be down almost 40 per cent from the peak by Christmas.
It gets worse too, because when you account for tax at 30 per cent and then remove inflation (which the Reserve Bank expects to be 2.5 per cent this year) your real return is very close to zero.
It might be time to dump the deposits and get some of that capital working a bit harder.
There is a range of options out there, and they don’t all involve moving up the risk curve and introducing significant volatility to your investment mix.
A combination of fixed income, both domestic and international, diversified funds, real estate exposures, and income-generating equities might deliver better bang for your buck over the coming period.
For many conservative investors, the term deposit party’s over and it’s time you spoke with your investment adviser about how to bridge the income gap.
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Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.
Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.