Are term deposits risky?
Christine St Anne  |  30/11/2012Text size  Decrease  Increase  |  

Christine St Anne: It's not surprising that many investors flocked to term deposits during the global financial crisis, given their perceived safety. But how safe are these assets? Today I am joined by Ibbotson's Brad Bugg to discuss the volatility behind term deposits. Brad, welcome.

Brad Bugg: Nice to be here.

St Anne: Brad, term deposits are perceived as safe assets. Are they actually more volatile than investors think?

Bugg: Well, I think, from a risk perspective, term deposits have done a very good job of preserving your capital, and post the GFC I think that has been the number one concern of investors.

But one thing I think they have ignored is the volatility of the income, which comes from a term deposit. We are at now in an environment where the RBA is starting to cut the cash rate, and as a consequence the banks are starting to bring those term deposit rates down. The RBA has cut cash rates by 1 per cent over the last 12 months and term deposits have come down to a similar degree.

So, investors who were investing in term deposit 12 months ago, the income which they are going to get from the new term deposit could be anywhere from 20 per cent lower to a third lower. So, we think that's a big risk for pensioners who are relying on that income to survive.

St Anne: You mentioned the volatility of income, are there any other risks behind term deposits?

Bugg: I think one of the biggest risk is complacency. In 2007 investors could get term deposit rates of 7 per cent to 8 per cent, and they could lock that in for five years. So, that was an easy decision for investors because it gives you that capital preservation and the nice income going forward. But now sort of we are in a period where sort of term deposit rates are quite low and people have gone back to term deposits because they've given the outcomes that they wanted in the past, but that's meant they've ignored some good opportunities where they could have protected their capital, but still get a better return and from that you could have look to Australian or global government bonds, for instance, which gave you a return of more than 10 per cent over the last 12 months.

So, I think, there is that complacency that people go back to what they know, but there are other opportunities that they are missing out on. So, we think investors need to take a more dynamic approach where they look to vary their allocation to different assets, depending on the opportunities that are present at the time.

St Anne: So, how does the risks behind term deposits impact the retirement plans for investors?

Bugg: Well, retirees look to the income that's coming from these term deposits to pay the bills whether to pay the water bill, the utility bill. These bills are going up at some quite alarming rate in many instances. And with reinvestment of term deposits probably for the last 12 to 18 months, each time they've rolled over term deposit they've been getting lower income from that term deposit.

So, just to give you an example, Westpac offered a five-year term deposit at 8 per cent many years ago. Had you locked that in that would be fantastic, but now you are looking at rolling that term deposit over in a couple of years time at a rate which could be half that. So, if for instance you had all your money in that, you are going to see the income that you rely on to live halved, which I don't think is an outcome a pensioner would look to.

St Anne: Brad, you mentioned bonds, what other assets can investors look at besides term deposits and bonds that can give them some sense of capital protection?

Bugg: Well, I think, term deposits have been very good from that perspective in protecting investor capital. Bonds have also done a good job in a falling interest rate environment, and we don't think that's going to be the case going forward.

So, we look to just plain vanilla cash, having money in the bank account because that does preserve your capital, but it also gives you that flexibility to capitalize on opportunities should other assets fall and start to present some interesting valuation.

So, we think that sort of cash gives you a good option value which you are not getting with term deposits because your money is locked up for the life of that term deposit.

St Anne: Brad, so ultimately is there a role for term deposits?

Bugg: I think so, because term deposits do give you a certainty of income, but we wouldn't recommend that you have all your investments in term deposits. We recommend sort of having a diversified portfolio and varying those allocations over time, and having the biggest allocations to those assets which give you the best reward for your risk, and at the moment West is starting to see the reward for risk portfolio from term deposit being not as advantageous as some other asset classes out there at the moment.

St Anne: Brad, thanks so much for your time today.

Bugg: Not a problem.

Video Archive...

Should prudent investors be near Rio Tinto?
12/02/2016  Morningstar's Peter Warnes gives his take on the latest batch of results from the likes of Commonwealth Bank of Australia, Cochlear and Rio Tinto.
Building wealth with building materials
09/02/2016  Morningstar's Tim Mann examines those stocks poised to benefit from strong housing activity and a strengthening US economy.
Safe withdrawal rates for retirees
02/02/2016  Morningstar's Anthony Serhan explains why retirees in Australia should use lower initial safe withdrawal rates than those suggested in prior research.
Key factors for picking dividend-payers
01/02/2016  The income stream from dividend-payers can play a special role in funding portfolio withdrawals, says Morningstar's Josh Peters.
What is alpha and why should you care?
27/01/2016  Alpha is often described as the extra profit delivered by fund managers on top of market returns. Understanding alpha can help you make better investment decisions.
Australia offers investment growth
20/01/2016  Sentiment towards Australian equities has been unduly negative, says Fidelity's John Lo, and alongside Korea, Australia is providing an unexpected boost to portfolio returns.
Credit securities: The good, the bad and the ugly
14/01/2016  The ability to meet payments and obligations to investors is what separates a good credit security from a bad one, and moat-rated issuers have a stronger ability in this regard.
Why the world is worried over China
13/01/2016  Knock-on currency effects and trade concerns are weighing on, in some cases, fully valued global markets. The result: a rocky ride for investors.
What's fueling the volatility in China?
08/01/2016  Fundamental, technical, and behavioural factors are all at play in sending Chinese and global shares lower, says Morningstar's Dan Rohr.
China woes to cause market volatility
08/01/2016  The US economy is mostly insulated from a slowing China, but that doesn't mean a smooth ride ahead for global stock markets, says Morningstar's Bob Johnson.
ETF investing rules of thumb
05/01/2016  There are many potential benefits to ETF investing but there are a number of rules investors should heed in order to avoid problems.
Top tips for small-cap investing
14/12/2015  The founder of the Eley Griffiths Group gives investors an idea of what to look for should they wish to dip their toes into small-cap waters.
Does the Japan stock market have further to rally?
10/12/2015  Japan was tipped as the hot market for 2015 and it has lived up to predictions. So how much further does the Nikkei have to rally?
Key stock evaluation metrics
08/12/2015  Australian Foundation Investment Company managing director Ross Barker discusses how he and his team go about assessing stocks with long-term prospects.
The most important statistic for dividend investors
03/12/2015  The payout ratio--the dividend rate divided by earnings--can give you an idea of how well covered the dividend is, and how likely it is to grow, says Morningstar's Josh Peters.
Tailwinds blow for Europe and Japan
01/12/2015  Given their solid forward earnings growth prospects and policy tailwinds, European and Japanese equities look favourable, BlackRock's Stephen Miller says.
The importance of valuation
25/11/2015  Valuation is critical as it drives both risk and return, and buying the wrong asset at the wrong time can have devastating consequences.
2016 another difficult year for emerging markets
24/11/2015  Emerging markets veteran Hugh Young of Aberdeen admits that 2015 has been hard for investors but says stocks are cheap and there are gains to made over the long term.
Emerging markets: down but not out
18/11/2015  Emerging economies have struggled in recent years, but their increased productivity, stronger population growth, and rising middle classes represent an important growth opportunity for the future.
Characteristics of quality investments
17/11/2015  While markets may be constantly changing the traits of good-quality companies remain the same, Celeste Funds Management's Frank Villante says.