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Term Deposits

What are the conditions attached to a term deposit or non tradeable fixed interest security?

A term deposit is an account held by a bank or financial institution in your name, for a period of time that you choose. Usually that time can be selected from terms between one month and five years. You then deposit an initial investment into your term deposit account and your chosen term begins.
During the term of the investment you cannot access your funds and you cannot add funds to the deposit. Instead, interest is calculated daily on your investment balance, and that interest is paid to you as a return on your investment. Interest can be paid monthly, quarterly, six monthly, annually or at maturity. If you do not require the income, banks may offer you the opportunity to compound the interest but this is generally only offered on terms of 6 months or greater. For terms of less than 180 days interest is paid at maturity. At the end of the term you can choose to reinvest your original amount, reinvest the interest or withdraw your investment and the interest earned.
 
A typical term deposit includes the following basic characteristics:
  • Fixed interest rate:When you open a term deposit account the interest rate is fixed for the life of the term and the investment will earn the same amount of interest every day no matter what change the bank makes to its standard variable rate, and notwithstanding any decision that the Reserve Bank of New Zealand makes to the official cash rate.
  • Assured principle and return: Because you are investing your money in a bank account there is minimal risk that your investment capital will go down in value. This would generally only occur if the bank was to go into default. Investors must therefore be comfortable and aware of the underlying risk associated with the particular bank they are investing in. Similarly, because you know the interest rate your investment will be earning, your return should also be assured, and you know what that return is from the beginning.
  • No access to your funds during the term of the investment: Term deposits are for a fixed period unlike tradeable securities such as bonds. Investors should be aware therefore that funds need to stay with the bank for the duration of the term.
 
Words of advice regarding investing in term deposits:·        
  •  When considering investing with a bank, ensure that you are comparing “apples with apples” as far as the underlying security is concerned. The easiest way to undertake this comparison is to compare the various banks’ credit ratings with Standard and Poors. (see an explanation of these credit ratings in the Standard and Poors section of this website) Be aware that just because a financial institution calls itself a bank, this does not guarantee that it is of a similar security to its peers.
  • The current environment is such that banks in New Zealand need to compete aggressively for funds in the retail market. For the first time in many years, retail investors are being offered higher deposit rates that what are being offered in the wholesale market. Shop around to ensure your bank is competitive with what else is being offered by other banks. If you don’t want to “change” banks ensure that you inform your bank that you can obtain a better rate elsewhere. In the majority of cases banks will match what a competitor is offering. For larger amounts seek quotes across a range of banks – it is highly likely that the rates you are offered will be considerably higher than what are advertised.
  • If your bank isn’t prepared to match a competitor’s rate be aware that transferring a term deposit does not necessarily entail having to open a completely new bank account with another institution. In many instances banks will gladly open a term deposit account only as opposed to a complete transactional facility.