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Prospecting for greater cash returns

Nicki Bourlioufas  |  05 Dec 2016Text size  Decrease  Increase  |  

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Given the prospect of a more inflationary world, term deposit rates are expected to eventually move higher. But should investors wait for higher returns next year or lock in now?


Following Donald Trump's election victory in the US, bond yields finally started rising across the globe after being at record low levels for a long time.

That could push term deposit rates higher next year, though experts say not to expect a great lift.

Term deposit interest rates are typically priced off bond yields, that is, wholesale market interest rates. While a rise in official interest rates may put upward pressure on at-call or shorter-term deposit rates, three- and five-year term deposits are typically priced off bond yields.

With the prospect of a more inflationary world with Donald Trump at the helm in the US in 2017, bond yields have already risen slightly. If that continues, term deposit rates are expected to eventually move higher too, though not necessarily by a great amount.

According to Australian interest-rate monitor, The Yield Report, not much has happened yet. AMP Limited (ASX: AMP) recently raised its four-month rate by 85 basis points to 2.35 per cent, six-month rates by 40 basis points, while one-month, two-month and one-year rates were all increased by 20 basis points.

Bank of Queensland (ASX: BOQ) also increased its four- and five-year term deposit rates rose by 10 basis points and 20 basis points respectively, according to the weekly Yield Report Survey.

But at the same time, and perhaps it's no surprise, some banks are still dropping term deposit rates. According to the survey, the nation's biggest bank and retail deposit taker, the Commonwealth Bank of Australia (ASX: CBA), recently reduced its three-month term deposit rates by 5 basis points, while one- and two- year rates were cut by 15 basis points and three- and four-year rates were reduced 10 basis points.

If you're thinking of locking into a term deposit, should you wait for possibly higher term deposit returns next year or lock in now?

Financial adviser Bruce Brammall of Bruce Brammall Financial says there isn't likely to be much benefit to waiting and locking in a term deposit in 2017 rather than this year.

"There's not likely to be any great move in the cash rate or term deposit rates in coming months and it might be that the price of waiting three or six months won't be offset by any increase in term deposit rates," says Brammall.

He says the extra costs involved with investing in cash-focused managed funds, including platform and management fees, may not be worth the cost either with interest rates at such low levels.

"As cash returns aren't that great, you are probably better off having the money invested off-platform in a term deposit," he says.

The same is also true of an exchange traded fund (ETF), where the fund provider will charge a management fee for managing the product and investors also need to pay brokerage fees, costs not necessarily recouped by any extra returns offered by these products.

"The advantages, however, to both are that your money remains liquid and isn't tied up for a term," says Brammall.

Morningstar senior research analyst Tim Wong agrees and says most cash funds aren't offering returns that match the highest available term deposit rates.

"However, cash funds offer accessibility to your capital, unlike term deposits which are locked in for a set period. Cash funds may also be convenient to administer for investors using managed fund platforms," he says.

While higher term deposit rates eventually may please cash investors, they should also note that unlike shares, which receive benefits such as franking credits, returns from cash investments don't enjoy any favourable tax treatment. Returns are taxed at your marginal tax rate plus Medicare levy, which can be as high as 47 per cent.

According to the Yield Report Survey, the highest term deposit rates on two- and three-year term deposits is 3.2 per cent, with five-year rates as high as 3.3 per cent. But that means locking your money away for years.

In contrast, yields on CBA shares are around 5.4 per cent and on National Australia Bank (ASX: NAB) they are as high as 6.8 per cent, with after-tax returns even higher for investors on a lower marginal tax rate given the benefits of franking credits.

As Brammall says, to get a higher yield, "you need to chase higher risk".

So, all up, while bond yields may move higher, don't expect any great jump, particularly in Australia where inflation rates remain very low, which will limit any rise in bond yields.

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

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