A term deposit and a bond both fall under the category of fixed incomes. They are relatively risk-free investments that you can use to diversify and strengthen your portfolio. And like all investment options, they both come with their fair share of pros and cons. To maximise your returns, you need to first understand how investment bonds and term deposits function in a real-world environment.
Term Deposit vs Bonds: Similarities and Differences
A term deposit functions like a high-interest savings account. You put your money into a term deposit and it will achieve higher returns than a regular bank account. An investment bond is a way of lending money to a government or a corporation. Because the entity owes you money, you can collect regular interest on the bond. When the bond has fully matured, the government or corporation must repay the original sum of the loan. Both are considered safe places to store your money, but term deposits are generally considered even safer than bonds.
Source: Financial Samurai
Building Your Financial Portfolio
Both term deposits and bonds can be important parts of a strong portfolio because they provide consistent returns. In the case of a term deposit or a government bond, the investor is virtually guaranteed a payout up to $250,000.
In the case of a term deposit, this investment strategy fully protects the holder against the volatility of the markets. So even if there’s a huge crash, the returns will not be affected. In the case of a government bond, a sovereign government has the option to raise taxes or to print money in order to keep up with their obligations. People who buy bonds sometimes refer to their revenue as coupon income, meaning a consistent stream of slow but steady returns. The capital stability looks great on your portfolio, even if it’s not a staggering display of wealth.
For a term deposit, it’s the interest rate that matters most when determining the yield. Term deposits generally lock in that interest rate at the very start, making it easy for investors to plan ahead. However, term deposits are an illiquid investment strategy. Once the money is locked away, an investor will have a difficult time cutting the term short. Bonds generally give investors the option to sell prior to maturation, making them more flexible and ultimately giving some investors more peace of mind if they run across an emergency situation.
Term Deposits vs Bonds: Pros and Cons
Term deposits have historically been a popular way to invest, but its low-interest rates have people rethinking their strategies. Because the interest rates are expected to remain low in Australia and because term deposits don’t account for inflation, the returns may not be enough to justify this investment strategy. Many financial experts are seeing people turn away from term deposits to investment grade bonds. Bonds offer higher returns when combined with riskier ventures, such as equity.
Investors do have to be careful though when choosing their bonds because some are riskier than others. With hundreds of categories available, investors have to do more research to find out exactly who they’re lending money to.
For example, a corporate bond may boast a higher return rate than a treasury bond, but it’s also less likely to be paid back (in full) to the investor. Bonds can also be traded on the secondary market so unlike a term deposit, their prices may rise and fall. This can work to an investor’s advantage, allowing for the possibility of capital gains if choosing to sell the bond before maturation.
However, price fluctuation can also work to an investor’s disadvantage if the prices continue to fall with every trade. The volatility of the bond market is typically nowhere near that of the general stock market. But there is no requirement to sell the bond, once you purchase, you know with precision your income to maturity. The market fluctuations do not impact the investments you hold.
As investors discover more about the wide world of corporate and government bonds, they’ll see the discrepancies between the yields of both. Corporate bonds tend to offer the most attractive terms, reflecting the risk behind them. But no matter which bonds an investor chooses, they’re more likely to see income returns over that capital growth.
Term Deposit Maturation
When a term deposit matures, investors will receive information from their financial institution about how much interest the account has earned and what investors can do next. If investors want to roll the money into their next deposit, they have the option to shop for a competitive interest rate so they can increase their return. The problem is that the difference between the lowest interest rate offered and the highest one an investor finds may be negligible. Until interest rates begin to climb again, experts are recommending term deposits for those with short-term investment goals who don’t want to take risks with corporate bonds.
Finding the Right Investment for You
When it comes to choosing between term deposits and investment bonds, there is no right or wrong answer. Every investment strategy depends on your current portfolio and your personal comfort level when considering the different risks.
If you are curious about the many different categories of investment bonds and want to learn more about how they fit into your portfolio, contact Australian Bond Exchange today.