Investment Guide

Term deposits: A simple guide for Kiwis

Term deposits, also known as term investments, are a popular savings option offered by banks and other financial institutions. They can provide a low risk, reliable way to grow your money, helping you work towards achieving your financial goals.

This article will be your one-stop guide to understanding term deposits, including how they work, their pros and cons, and how to choose the right one for you.

What is a term deposit?

A term deposit is a fixed-term investment option that offers a pre-determined interest rate for a set period.

You deposit a specific amount of money (usually there's a minimum amount required) for a predetermined term (ranging from a few months to several years). In return, the provider offers you a fixed interest rate. You cannot access your money during the term without incurring early withdrawal penalties. Once the term deposit matures (comes to its end), you'll receive your initial deposit plus the accumulated interest. However, depending on your agreement with your term provider you may be able to have your interest paid out during the term (such as quarterly).

Term deposits may be a good choice for people looking for:

Security: Your principal amount (the initial amount you deposit) is fixed with a term deposit, making it a lower-risk investment option.
Predictability: You'll know exactly how much interest you'll earn over the term, helping you plan your finances.
Flexibility: Term deposits come in a variety of terms to suit your needs, from short-term goals to long-term savings plans.

Term deposits and interest rates

Interest rates are essentially the "cost" of borrowing money. When you put money in a term deposit, you're essentially lending your money to the financial provider. The interest rate is the fee they pay you for borrowing your money for the term.

When interest rates rise, the return on new term deposit investments increases. If you’re about to open a term deposit, a higher interest rate may mean more earnings.

On the other hand, when interest rates fall, so does the return on term deposit investments. If you have an existing term deposit, interest rate drops won’t affect you until your term ends.

Interest rates are constantly changing based on various factors like the overall economy, inflation, and government monetary policy. In New Zealand, the Reserve Bank sets the Official Cash Rate (OCR), which influences interest rates offered by banks, credit unions, and other financial institutions.

When a term deposit matures

When your term matures, a few things can happen depending on your prior instructions and the bank or financial provider policy:

Automatic renewal

If you haven't specified otherwise, or if you have instructed your term deposit provider beforehand, your provider may automatically renew your term deposit for another term of the same length with the current interest rate offered on the maturity date. Be aware that the new interest rate might be lower than the one you originally received.

Payout to your account

If you instructed your term deposit provider beforehand, they will deposit the matured amount (your principal amount plus any accumulated interest) into your designated account.

Other Options

Some providers might offer you the option to partially withdraw your principal while reinvesting the remaining amount for another term. You might also be able to transfer the funds to a different term deposit with a different term length or interest rate.

It's important to check the terms and conditions of your Term Deposit and actively choose your preferred option before maturity.

What to do before your term deposit matures

Before your term investment matures, it’s a good idea to be proactive in understanding your options. This ensures a smooth transition when your term matures and helps to maximise your returns. Here's what to do before your term deposit matures:

Review your options

Check your initial agreement or contact your bank, credit union or other chosen provider to understand the automatic renewal policy and available options at maturity.

Decide what you want to do

Do you want to renew, withdraw, or explore other options? Make sure to communicate your decision well before the maturity date.

Compare interest rates

If you're considering renewing, compare the current interest rate offered by your current provider with rates from other financial institutions. You might find a better deal elsewhere.

What are the pros and cons?

Advantages of term deposits

Term deposits offer a fixed interest rate over a specific period. So, unlike a high-interest savings account where rates can fluctuate, they offer a predictable return on your investment. This can be particularly beneficial for retirees or those who are risk-averse and prefer a conservative investment approach.

Another advantage is the comfort that the value of your initial deposit amount won’t change, ensuring the protection of your hard-earned money. Unlike other investment options that may be subject to market ups and downs, term deposits offer a sense of security and peace of mind, making them a lower-risk investment option.

It's worth noting that interest rates can vary depending on the duration of the term and the amount of your deposit. Longer terms generally offer higher interest rates, allowing you to maximise your returns.

Disadvantages of term deposits

Like any investment, term deposits have their drawbacks. For instance, your money is locked in for the duration of the term, and withdrawals before the maturity date may result in penalties. This means your money may not be available right away if you need it. It's crucial to carefully consider your financial situation and potential future needs before committing to a term investment.

Additionally, term deposits may offer lower returns compared to other investment options, such as stocks or managed funds. And while they provide a stable and predictable return, the fixed interest rates may not keep pace with inflation. Over time, what your returns can buy today might not buy as much in the future. It’s important to think about your financial goals. Will a term deposit's returns help you reach them in the timeframe you need?

How to choose the right one for you

Here are some factors to consider when choosing a term deposit:

Do your research: Compare interest rates, terms, and conditions offered by different financial providers to find the most suitable option for your needs.
Consider your goals: Align the term length with your financial goals. Short-term needs might be better suited for a high-interest savings account, while long-term goals can benefit from a longer-term deposit.
Minimum deposit requirement: Ensure you have the minimum amount required to open a term deposit. The minimum amount can vary across different financial providers.
Negotiate your rate: If you're a loyal customer or depositing a larger amount, you may be able to negotiate a slightly better interest rate.
Early withdrawal fees: Understand the penalties for withdrawing your money before the term ends.
Interest payments: Choose whether to receive interest payments throughout the term or in a lump sum at the end. If your chosen term provider gives you the option to reinvest your interest payments, this can help your money grow faster through compound interest.
Tax on interest: The interest you earn is considered income and will be taxed.
Financial institution reputation: Choose a reputable and well-established financial institution that is government-guaranteed.
Seek professional advice: Consult with a financial adviser who can provide personalised guidance based on your unique circumstances and financial goals.

Things to consider before investing

Investing in a term deposit involves careful evaluation and consideration of your financial goals. Here are some things to consider to help you make an informed decision:

Your money is locked in: If you need access to your funds early, you may face penalties in the form of early withdrawal fees.
Your risk tolerance: Consider how much risk you can handle with your investment locked away for a specific period. If you’re likely to need the money soon a term investment may not be the best option. If not, it could be the right choice.
Potentially lower returns: Term deposits typically offer lower returns compared to other investments like stocks or managed funds.
Interest rate changes: Interest rates can change over time. While you'll earn the fixed rate you agreed to initially, it's possible that if interest rates go up in the future, you could have potentially earned a higher rate by choosing a new term deposit with the current, higher interest rate. This is the trade-off for the security of a fixed rate with a term deposit.

Frequently asked questions

Is a term deposit right for me?

Term deposits can be a valuable part of a balanced investment portfolio in New Zealand, but they're not a one-size-fits-all solution. Things to consider before you invest include; whether investing in a term deposit aligns with your financial goals, if you’re comfortable with having your money locked away for a set period and understanding the potential for lower returns compared to other investment options.

While term deposits can be great for short-term savings goals or those seeking low-risk options, they may not be the best choice for maximising returns or long-term wealth growth.

Are term deposits safe?

Term deposits are generally considered a low-risk investment. In most countries, they are insured by government agencies for up to a certain amount, protecting your principal in case the bank, credit union or financial provider fails.

Is it worth putting money in a term deposit?

They can be a great option for those saving for upcoming expenses like a holiday or a deposit on a home. While interest earned may not be as high as other types of investments, the security and fixed returns they offer make them an attractive option for those wanting to park their money in a low-risk place.