Cashing in on term deposits

PORTFOLIO POINT: Lower official interest rates have seen financial institutions cut their savings deposit yields, but there are deals out there for those willing to shop around.

It’s a while since I checked the offerings on bank term deposits. All the banks have taken to their term deposit rates with an axe, and the rates have fallen sharply. That means that all those using bank term deposits need to look more closely at the percentage of money they have in this category, which is why the Eureka series on the hunt for yield is so important. Our recent coverage includes features on new life in REITS (click here), US property funds (click here), and the attractions of this week's float of Woolworths property assets (click here).

But today I want to offer a guide to the yields available in cash. To those looking for bank term deposits, the blow of declining rates can be lessened by careful shopping.

It’s important not to simply take the ‘big four’ term deposit rate card if you have a substantial sum and/or you are investing for more than six months. Before we look at the best rates on offer, there are a few points all term deposit investors and those investing in fixed-interest securities should keep in mind. Most people are forecasting that interest rates in Australia are going to fall further. That means that even though term deposit rates are less attractive than they were, it is likely that they will become even less attractive in a few months’ time.

The stimulus effects of lower interest rates on demand are minimised once you fall much below current levels. We have seen from the US, parts of Europe and Japan that very low rates don’t affect consumers a great deal, but they do eat into the disposable income of retires.

And, at least in Australia, further rate reductions are likely to lead to a housing bubble. Australians have a love affair with lower interest rates and housing, and in most areas of the country you can see housing prices beginning to stabilise or increase. Further rate falls could be a real danger.

Behind the money flow

Reserve Bank governor Glenn Stevens is very conscious that lower interest rates hit retirees, but he has a real dilemma in that our rates are higher than in other countries with similar credit rating standards. As a result, we are receiving large sums of money into Australia, which is inflating the Australian dollar. In turn, this is making life very difficult for our employment-creating industries. Lowering the dollar is now probably the main motivation for reducing interest rates. Always remember that if you were in Japan, Germany or the US and you saw that Australian banks were guaranteed by the Australian government for term deposits up to $250,000 you would be over the moon. Interest rates in those countries are very low, and if you could get 4% and 5% interest rates and a government guarantee in those countries, it would be the source of great joy.

With interest-bearing securities it is rarely worth hunting for high interest rates if you are at all worried about the security. With an equity-style investment you have upside if the business does well. With loan deposits there is no upside, and gaining an extra couple of percent while jeopardising one 100% of the your capital is not wise. In any interest-bearing investment that carries no equity kicker, you need to be certain you are going to get your money back. That’s why investing in finance companies, and the like, where there is a doubt about capital repayments, is simply not a prudent thing to do. Ask Banksia investors. And, repeating the wonderful aspect of Australian term deposit lending is that deposits of up to $250,000 carry a Commonwealth government guarantee.

Self-managed fund investors have a major advantage over professionally managed pool funds. Professional managed funds control billions of dollars, and so the $250,000 government guarantee is simply not relevant for their term deposit investments. Many professionally managed funds do not use term deposits on a large scale. But self-managed funds are able to spread their deposits and affectively have a government guarantee security that yields way above government bonds. So that is why, provided you keep your deposits in each bank below $250,000, you can shop around. Having said that, I always prefer not to have to rely on a government guarantee.

Term deposit rates on offer

So let’s look at some of the better rates that are on offer. If you want to have a term deposits of six months or one year, then there is one top-four owned bank that almost always offers the best rate – UBank, which is part of the NAB. UBank requires electronic communication but its rates for currencies between six months and one year are rarely matched by anyone else, although ME Bank tops it. The UBank six month term deposit rate is 4.66%. Bank of Queensland comes close to UBank with 4.65%, but ME Bank offers 4.7%.

The top UBank rate for one year is 4.68% and the bank claims that can be increased to 4.78% if you roll over. In other words, if you leave your money in you get an increased return. Few other banks match UBank, at least in their published rates. Unfortunately six months ago you could obtain 5.31% from UBank, so the current one-year rate is well below that of six months ago. But if you simply walked into a big four bank and asked for a six or 12-month deposit you would receive between 4.2% and 4.4%. UBank assumes their customers will not shop around, although in fairness the CBA’s BankWest offers 4.6% for nine months, which is competitive.

Once you move into longer-term rates there is a smorgasbord of opportunity. In the two-year rate there are a series of banks with similar offerings. They include Rabo Direct (4.5%), Bank of Queensland (4.4%), BankWest/Commonwealth (4.4%), ME Bank (4.5%), and Macquarie (4.45%). Note the rates have come down for longer terms, indicating that banks think rates are going to fall. As you move into even longer rates, the stand-out performer has traditionally been Rabo, which has a top rate of 4.8% for five years. The Rabo five-year rate is also matched by Macquarie Bank. But two other banks have now come over the top of Rabo in five-year rates. The first is Toowoomba-based Heritage Bank. I must confess that I have never considered the Heritage Bank and didn’t know much about it. It is a bank that is basically a cooperative. But, most importantly, it does carry the government guarantee.

I am always wary of high interest rates because they often signal that the borrower is taking high risks with their loans. I have no reason to suspect that with Heritage Bank, but in any case we have the government guarantee. The second bank to offer 5% for five years is AMP Bank, but the offer applies to amounts of $25,000 and above. Of course, Rabo Direct is a European bank and as we all know a large number of the European banks have enormous hidden bad debts. Many would be technically insolvent if they valued their lending on the market basis. Rabo is also a cooperative-style bank and so far has been able to keep itself separate from the crazy practices that have plagued its European counterparts.

Don’t be frightened to negotiate.

There are a lot of banks making very generous offers on short- term deposits as a way of wooing your transaction business. I am not a great fan of these sorts of deals unless you are very happy to have your transactions with the bank. However, it is possible to use the value of your transaction business in negotiations with banks. Once you have a sum of $25,000 to put on term deposits you can use leverage in most situations and banks will pay over and above standard rates to gain transaction accounts.

Similarly, if your deposit is maturing, don’t be frightened to play hard ball. In this commentary I am using only the published rates. If your bank’s rate is simply not competitive in the currency you are looking for, then you are probably wasting your time negotiating. But if they are close, give them a try. Your transaction business is very valuable to your bank.