Term Deposits
9 March 2022

Beware: The term deposit!

It is not often that people put their money into an investment when they know they will lose money. Sure, people often enough put their money into things when there is a higher risk of loss, but generally, they only do that when they hope to be well rewarded by means of superior return.

But at the moment, there is a lot of money in investments that are virtually certain to give a loss and, even so, the chances of any decent reward sits somewhere between very low and non-existent.

This investment is, of course, term deposits (TDs). In today’s economic climate, investment in these is sure to make you poorer.

The losses from TDs and the likes are real losses – i.e., losses that are after tax and inflation. Let’s look at an example: say that you took a one-year TD at 2.4 percent, you then need to deduct taxation and likely inflation to get the real rate of return:

Term Deposit 2.4%
Less Tax (17.5%) (0.42)
Return After Tax 1.98%
Less Inflation (5.9%)
Return After Tax and Inflation -3.92%

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This little exercise shows clearly that those who take a TD like this will be significantly worse off a year later (their money will have 4.2 percent less spending power). It seems extraordinary that people would knowingly put their money into something that is sure to lose.

Inflation is a scourge. It steals from those who put their money in the bank and gives to those who borrow from the bank and invest in things like shares and property. It does this very quietly; like rust, inflation does its dastardly work while we sleep.

Here’s a true (albeit quite extreme) example of the effects of inflation: we bought our first house in 1976. We managed to get a mortgage to buy it, and this mortgage was interest-only at 5 percent per annum. The mortgage itself was $6,000 (that seemed like a lot of money at the time; the house cost $8,000). If we still owned this property with its mortgage and paid nothing off the principle, that $6,000 would seem a pathetic amount of money today and could be easily repaid; effectively inflation would have paid off that mortgage for us.

But think of this from the other side: the people who loaned us the money would have seen their investment erode. They started with an investment of $6,000 which might have bought a couple of good cars in those days. But that would have slipped away to be worth barely the price of a pushbike.

Inflation stole from these lenders and gave to us the borrowers.

This example is extreme because the time is so long and inflation was high at times. Nevertheless, the inflation we have today (about 6 percent) works the same way to make those lending money poorer by the day. It may not be as dramatic, but it is gnawing away just the same.

With inflation possibly getting a boost from the war in Ukraine, you should be very afraid.

Term deposits and the likes have been the go-to investment for retired folk for as long as I have been involved in finance (which is getting to be a very long time!). Many people have TDs as their main (or only) investment, and I am not sure this ever worked well; even when interest rates were, say, 12 percent, after tax and inflation (both of which were very high), there was little or nothing left for the investor.

An investment strategy of continually rolling over TDs was not right for retired investors in the past and probably never will be. TDs were never designed to be the dominant investment strategy for the long-term, with retired people holding all or most of their money in them. And yet there are still far too many people with far too much money in TDs.

To be fair, TDs do have a place. For a start, when a TD matures, investors will likely get their capital back in nominal terms, if not in real terms. Even though they do not come with a government guarantee (as they do in most places around the world), TDs are safe, predictable and come with little volatility: you are most likely to get your money on the due date.

As such, they are good for short-term savings – your money will be there when you want it.
The price of that safety and predictability is that TDs have low or negative real rates of return.

They are not a good investment product for those with long-term savings and, in particular, do very poorly in times of higher inflation.
Retired people are likely to be retired for 20 years or more and so need a decent long-term investment strategy. They need to do better by investing across all investment types: shares, property, fixed interest and some cash.

You may build yourself a portfolio with exposures to all of these investment types, or you may buy into a ready-made managed fund like KiwiSaver or the Lifetime Retirement Income Fund (Click to Learn More). These diversified portfolios are likely to be much better investments for retired investors than TDs ever will be.

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Written by:

Martin Hawes

Martin Hawes is a Director and shareholder of Lifetime Asset Management Ltd. Martin also has a role with Summer KiwiSaver, for whom he writes articles and presents seminars. He believes this information is correct, and he has reasonable grounds for any opinion or recommendation on the date of this publication. Nothing in this article is, or should be taken as, an offer, invitation, or recommendation to buy, sell or retain a regulated financial product. Martin Hawes is a Financial Advice Provider, and his disclosure statement is available at www.martinhawes.com

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