Interest rates are at all-time lows on term deposits, while interest rates on online savings accounts sit barely above the inflation rate. While some wealth managers have been recommending investors increase cash allocations given equity market volatility, returns remain disappointing.

There are four main options for investors: online savings accounts, term deposits, cash management accounts (CMAs) and cash management trusts (CMTs) or cash managed funds. Interest rates on all such fixed income investments are very low after many years of easy monetary policy.

A CMA is an individual bank account which earns money market interest on cash balances. In some cases, returns sit below those available on term deposits. CMTs managed funds, where the unit holders’ funds are pooled together and invested in pure cash, bank bills and short-term bonds.

While bank savings accounts and term deposits generally carry no or low fees, CMAs and CMTs general charge fees and often minimum balances apply to both CMAs and CMTs, higher than those on term deposits.

Tim Wong, associate director, fixed income strategies at Morningstar Australia, says that fees vary on cash managed funds. Several vehicles cost between 20 basis points to 30 basis points, but they can be as high as 50 basis points or more particularly for retail funds sitting on platforms.

“Cash managed funds may give you slightly higher returns, and that is usually because they invest in securities with slightly higher credit and liquidity risk than pure at-call cash. Fees will typically depend on the fund’s investments as well as how the fund is distributed,” says Wong. He adds that fees on cash exchange traded funds (ETFs) can be lower, between seven and 18 basis points.

“That contrasts to bank deposits which have a government guarantee up to $250,000 and you aren’t paying a management fee,” Wong says. However, investors can incur break fees with term deposits if they want their money back before maturity, and that is a drawback of that vehicle type, a lack of liquidity, which an ETF or managed fund can provide.

Returns on pure cash are disappointing. According to data from the Reserve Bank of Australia (RBA), the average interest rate on a one-year bank term deposit was just 2.2 per cent in February 2018, down from 2.3 per cent a year ago. The average three-year rate was 2.45 per cent, down from 2.95 per cent in February 2017. So, term deposit rates are trending down despite slightly higher bond yields, off which terms deposits have traditionally been priced.

Andrew Lord, a director at wealth management firm Sherbrook Private, suggests his clients steer clear of cash investments given such low interest rates.

“Because of the low cash returns available, we have excluded cash from the adviser fee structure as any fee cost is going to deduct considerably from the gross return. Likewise, when investing in bonds, we are very mindful of the gross bond return less and that management, platform and advisor fees could take returns below that of bank bills,” says Lord.

“Investors can be exposing themselves to credit-like risk with less than bank bill returns. So, without taking undue risks, we are seeking out private market secured debt opportunities that have a liquidity component such as the Valara Partner Fund with term loans.

“Cash and bonds are providing a drag on portfolios overall returns, so rather than go further out the risk curve with equities or property, we prefer to lift up the base return with these private opportunities,” says Lord.

“It takes a lot more work, but the clients are appreciative for the opportunities.”

If you are considering a term deposit because they are fee-free and safe, the question of how long to lock in your savings in a term deposit is a key one. One option is to ladder or stagger your investment amount. This allows savers to invest in new term deposits at regular intervals, so they can take advantage of any future rise in interest rates, without committing all their money into a single term deposit for several years.

This is a flexible option for investors. When the expiry of each term deposit is reached, savers can take advantage of potentially more attractive interest rates. You can keep your term deposits to short staggered periods, in the hope that rates will rise.

Term deposits typically range from one month to five years. The way term deposit rates are set is that the longer the time is to maturity, the higher the interest rate. In other words, investors are rewarded for locking up their money for longer periods. Banks usually set term deposit rates regularly, as often as daily, as the market for investors’ funds is competitive as it is a relatively cheap form of funding for banks. But as the above data shows, banks aren’t increasing term deposit rates, even as market interest rates rise, in a bid to protect their profit margins.

More from Morningstar

• Your market downturn toolkit

• The ups and downs of dollar-cost averaging

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Nicki Bourlioufas is a contributor for Morningstar Australia. 

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.