With interest rates falling there is a really important warning that someone like me has to give anyone out there who is desperate for the good old days when term deposits were 5% or so. Right now, anyone wanting to save will have to have a lot of money to be offered more than 2% for socking away their money for more than a year in a Government-guaranteed term deposit at a bank.
These low rates for a safe bank deposit mean that the inexperienced saver could venture up the risk curve, which means they will be increasing the chances of losing their savings or seeing them shrink!
This morning I was asked to go on the Today show to talk about Chapter 3 of my book Join the Rich Club, which tries to show people how to become better at saving.
In case you haven’t checked lately, here are the rates of interest you can get from our big banks for $5,000 left in a term deposit over 12 months:
• CBA 1.45%
• Westpac 1.2%
• NAB 1.4%
• ANZ 1.4%
If you want to do better than this, you’ll have to consider putting your money into a bond fund, property trust, mortgage trust or a stock market fund that specializes in delivering dividend income or some other interest-promising product.
A bond fund is relatively safe but not as secure as a bank term deposit. The current returns are around 2-3%, though some gifted or lucky bond fund managers have produced bigger returns when interest rates move down quickly, after they have bought into bonds at much higher rates.
A property trust, such as the listed Scentre Group that holds buildings such as Westfield Shopping Centres, might have returns around 4-6% in terms of income but its share price on the stock market can go up and down, which adds to the upside but also the downside.
Mortgage trusts could return 4-7% but they can fail or they can delay returning your money, which is the risk that goes with higher returns.
Income funds listed on the stock market, like my own Switzer Dividend Growth Fund are designed to deliver dividends of 5-6%. With franking credits this could go to 7-8% and there also can be capital gain. Last year, we delivered 11.2% in total but if the stock market crashed, the unit price would fall. Funds like these and their unit price would generally come back but it could take some time. As long as these funds are invested in good quality stocks, the dividend income should keep on showing up, even in very bad years for the stock market.
And remember, dividends don’t fall like share prices. However, if someone is saving for a goal like a home loan deposit, a car or a holiday for a certain date in the future, a stock market crash or recession could stop them reaching their goal on time.
Aside from the products above, other saving vehicles or deposits accounts from lesser known financial businesses can offer attractive rates of interest but they can only do that by lending to more risky borrowers.You must remember that as the promised returns rise, so do the risks.
When a savings product is earmarked for sophisticated investors and may have minimum investable amounts of say, $100,000, you have to know you are not covered by consumer protection regulations.
These can be perfectly legal and well-intentioned businesses but they are more risky than a term deposit at a bank. That said, they could be no more risky than other products where your capital isn’t guaranteed.
Remember, as the return rises, so does the risk.
Saving for the long term is easy because many of us are in super funds, which have a history of good returns of 7% plus, but you have to wait until you retire to collect the income. Even these great saving vehicles can have bad years, as the GFC in 2008 proved.
Until a normal economy delivers more normal interest rates on term savings accounts, all those looking for income better understand that old Latin warning — caveat emptor, which means “let the buyer beware.”
When you put your money into an investment vehicle and are given a rate of interest, you are ‘buying’ into the lending strategy of the business that’s borrowing your money. So do your homework and know where you’re sending your money.