Episode Details

With term deposit rates currently ranging between 1% and 2% p.a., and the prospect of further rate cuts by the RBA, many investors are contemplating where to invest their cash. Most commentators and economists agree that it looks like the interest rate environment will be lower for longer. If that turns out to be true, term deposit returns won’t even keep up with inflation. Therefore, most people will need to consider alternative investments. However, there is one potentially costly mistake that people commonly make when doing this. That is the topic of this blog.

By the way, even if this doesn’t apply to you, it’s important to check that your parents aren’t making this potentially costly mistake. So, perhaps share this blog with them.

You cannot talk about returns without also talking about risk

Benjamin Graham, the father of value investing (and Warren Buffett’s teacher) said “The essence of investment management is the management of risks, not the management of returns.” This quote highlights the biggest mistake that investors make when considering alternative investments (to term deposits). They fail to consider risk.

Often, people may be tempted to invest in high-yielding Australian shares. As I highlighted in last week’s blog, Westpac (for example) currently offers a grossed up yield of nearly 10% p.a. That is hard to resist when you compare that to term deposit rates.

However, term deposits are almost risk free, especially if the amount is less than $250,000 and with a bank (ADI), as its guaranteed by the government. However, shares are one of the highest risk asset classes because they have a volatility rate in the range of 18% and 25%. This means that statistically, you should expect your investment returns to vary by this amount from year to year. For example, one year you might experience a 15% loss and the next year a 35% gain. Of course, it could be worse, and the market could crash. Share market and term deposits are at opposite ends of the risk spectrum.

Don’t put all your assets in a risky basket

The common mistake that people make is not considering their risk allocation. For example, Keith has been retired for 5 years and historically he had $350k invested in term deposits and $650k invested in shares. This asset allocation (35% in safe assets and 65% in risky assets) felt very comfortable to him. However, now his pool of “safe” monies isn’t generating enough income. So, if he invests this amount in high yielding shares, he’s making a big mistake (because typically, that asset allocation is too aggressive for a retiree.

At some point in our life (particularly in retirement), capital preservation becomes more important than investment returns. That is, avoiding losing money is justifiably more important than making money.

Telstra is a good example

Historically, investing in Telstra primarily for its high dividend yield was very popular trend. Over the past 10 years its grossed-up dividend yield has ranged between 5% and 10% p.a. However, spare a thought for the investors that chased high dividends in 2015 when Telstra shares were trading at $6 per share and the grossed-up yield was over 7% p.a. These investors have lost over 35% of the original value of their investment (which they may never recover)! Chasing yield, without any consideration of risk, is a recipe for disaster.

So, what are the alternatives?

There are a few alternatives to term deposits that warrant consideration (I list five below). Before I get into the list, I have a few