Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 95

The terms they are a-changin’

Come gather 'round people

Wherever you roam

And admit that the waters

Around you have grown

And accept it that soon

You'll be drenched to the bone.

If your time to you

Is worth savin'

Then you better start swimmin'

Or you'll sink like a stone

For the times they are a-changin'.

(From Bob Dylan’s The Times They Are A-Changin’)

The cash rate is heading for 2%, and term deposit rates are next to fall, yet term deposits and cash accounts are still the mainstay of most personal investment portfolios, including about 30% of the assets of SMSFs. Cuffelinks has previously written about alternatives to term deposits (‘Where to now for term deposit investors?’) and how some risks were not well understood (‘Term deposit investors did not understand the risk’). With rates falling and major changes to the terms and conditions of term deposits, investors need to rethink their rollover strategies. As Dylan says, “You better start swimmin’ or you’ll sink like a stone.”

The power of ‘retail inertia’

Back in the good old days, before political correctness, banks used to describe the willingness of customers to accept almost whatever was offered to them on term deposit rollovers as ‘retail inertia’. Banks could have a term deposit special at 5% and rollover similar deposits at 4% and the vast majority of customers accepted the lower rate. Retail inertia is still used by the banks today, even if it’s not called that. Check what it says on a typical term deposit rollover letter:

“If you have a special rate, that rate will generally apply for a single term. Standard term deposit rates may apply for subsequent terms.”

Which is bankspeak for: “You’ll receive a lower standard rate unless you ask for a special one.”

Why do banks offer special bonus rates for the first four months on some at-call deposits? At the end of the four months, customers fall to the ‘standard’ rate, and most don’t leave. A 0.3% bonus for 4 months is only equal to 0.1% per annum, an immaterial cost for gathering genuine retail deposits. It’s the same with credit cards and the ‘six months interest free’ for switching banks. They hope customers can’t be bothered changing again.

There is no incentive for banks to offer their best rates on rollovers. Consider some simple maths to show the true cost of paying up for the less sticky deposits. Assume $100 million of 12 month term deposits mature next week. $90 million of it will rollover if the rate offered is 3% and $10 million of it demands a higher rate, say 3.5%.

Question: If the bank wants to keep the entire $100 million, what is the effective rate (cost to the bank) on the extra $10 million?

Answer: The bank pays 3.5% on the full $100 million ($3.5 million) which is equivalent to 3% on $90 million ($2.7 million)  plus $0.8 million on the extra $10 million, which is 8%. Ouch!

Bank response: Raise the $10 million from new investors at a ‘blackboard special’ rate of 3.75% and rollover the $90 million at 3%.

Don’t ignore the bank letter

The rollover letter is not like the gas or electricity bill where the customer must accept the cost:

  1. Critically review the rollover rate. Most depositors tick ‘rollover for the same term on maturity’ when they open a term deposit, and if no action is taken, whatever rate is offered by the bank will be locked in. Most banks give a one week grace period if the rollover date is missed. When some term deposit offers now start with a ‘2’, the letters can no longer be ignored.
  2. Phone your bank and ask for a higher rate. First, go to a comparison web site like ratecity.com.au or mozo.com.au, and arm yourself with the highest rate. They’re all government guaranteed for amounts up to $250,000. Even if the bank is not prepared to match the offer from a small credit union, it will probably offer more than in the rollover letter.
  3. Watch other changes in terms and conditions. Changing liquidity regulations as part of Basel III mean banks will be far stricter allowing access to term deposits. In the past, banks permitted early access, often with no interest rate penalty (if term deposit access was obtained just after an interest payment, banks would not pay less than face value). Bank regulators realised this was unsatisfactory, as banks report the maturity profile of their deposits assuming none were repaid early. Now, all the banks are writing to customers saying funds cannot be accessed (even with a penalty) inside a 31 day notice period.
  4. Consider another term, although accepting higher rates for longer terms carries risks. Last month, I had a maturing five year investment originally placed with Westpac in January 2010. The previous rate was a handsome 8%, and even at the time, it proved extremely popular with Westpac raising $2 billion in a couple of weeks. Westpac's five year rate is now 3.9% and income has halved. It’s one thing accepting 3.9% (a real return of 2%) for a short-term, but too much market risk for insufficient reward over five years.
  5. Don’t leave the paperwork until the last minute. Although banks usually nominate a grace period to negotiate a rollover, some require attendance at a branch to verify a variation. In today’s online and mobile world of banking, it can be frustrating finding a branch just to sign a form. Also, the interest rate paid during the grace period is nominal, 0.5% to 1%, so act early.
  6. Consider an alternative. Looking at mozo.com.au for terms of 1 to 3 months, most rates are less than 3%. Where term deposits once offered decent rates at negligible credit risk, now they are giving little more than capital security. It’s worth considering alternatives such as corporate bonds, bond funds or listed securities, but they come with more risk. For some guidance, Australia Ratings has assigned risk ratings to 65 ASX-listed securities, all investment platforms have a range of bond funds and there are income-based ETFs.

Whenever you see the words ‘Automatic Renewal’ on a term deposit rollover, there’s a strong chance you can do better. Listen to Bob, who says at the end of the second verse: “For the loser now will be later to win. For the times they are a-changin’”.

 

Graham Hand has worked in banking and wealth management for 35 years and is Editor of Cuffelinks. This article is general information and readers should seek their own professional advice.

4 Comments
SMSF Trustee
February 09, 2015

Inflation of 10-20% over the next 6 months. Nonsense.

Of course rates are going to stay low. The world economy is not generating enough return on capital for them to go up, other than for the occasional trading 'correction' in the market. Certainly the Australian economy isn't generating enough growth for producers to have a snowflakes' chance of putting prices up. Importers have to suck it up.

I'm not going to manage my SMSF based on Bruce's outlook.

Bruce Bennett
February 08, 2015

This article, along with many other commentators, assumes that interest rates are going to stay low, or get even lower. Even the RBA has lowered its projected inflation rate for 2015. These commentators ignore the fact that importers are paying 30-40% more in Australian dollars for their goods than they were 12 months ago. As a result, I expect most companies will have to increase prices by 10-20% within the next 6 months.

And oil prices are also likely to rise from current levels. While some producers need the cash, others will take a longer term view and, with low interest rates, decide to keep their reserves in the ground, or place it in storage, until the price rises to USD60 or USD70/barrel.

Graham Hand
February 06, 2015

Thanks, Richard, for pointing out I had the right answer approached the wrong way. I have corrected it. Cheers, Graham

Richard Lyon
February 06, 2015

You must be an actuary!

The example produces the right answer, albeit scaled by a factor of 10, from the wrong maths.

To keep $100M costs a 3.5% rate = $3.5M.

At 3%, the bank would have kept $90M, at a cost of $2.7M, so the extra $10M has cost $0.8M (which is indeed 8% of the $10M, but is a long way short of $8M).

Paying 3.75% on the new $10M (and ignoring acquisition costs not even canvassed above) costs $0.375M, for a total cost of 2.7 + 0.375 = $3.075M, saving $0.425M (less acquisition costs) against the first option. That is 4.25% of the $10M, or 0.425% of the $100M.

Disclosure: I am an actuary

 

Leave a Comment:

     

RELATED ARTICLES

Australia’s economic outlook robust, but risks are rising

Retail yield enhancement via wholesale funds

Six ways to improve your term deposit outcome

banner

Most viewed in recent weeks

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Welcome to Firstlinks Edition 467

Fund manager reports for last financial year are drifting into client mailboxes, and many of the results are disappointing. With some funds giving back their 2021 gains, why did they not reduce their exposure to hot stocks when faced with rising inflation and rates?

  • 21 July 2022

Welcome to Firstlinks Edition 466 with weekend update

Heard the word, cakeism? As in, 'having your cake and eating it too'. The Reserve Bank wants to simultaneously fight inflation by taking away spending power, while not driving the economy into a recession. If you want to help, stop buying stuff.

  • 14 July 2022

Welcome to Firstlinks Edition 465 with weekend update

Many thanks for the thousands of revealing comments in our survey on retirement experiences. We discuss the full results. And with the ASX200 down 10%, the US S&P500 off 20% and bond prices tanking, each investor faces the new financial year deciding whether to sit, sell or invest more.

  • 7 July 2022

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.