By Leon De Wet – Elston Portfolio Manager
At first glance the answer may seem obvious, but is it? That depends on what an investor is looking to protect against. There is no doubt that term deposits offer capital stability and given the government deposit guarantee, are virtually risk-free. So, through the lens of protecting the capital value of one’s investment, they are undoubtedly defensive.
Should the question however be framed in the context of providing income, the answer is quite different. According to data from the Reserve Bank of Australia, over the past 10 years the average rate on a 1-year retail term deposit has more than halved from 3.70% to 1.80% at the end of June 2019. For a retiree seeking a stable income stream, term deposits have not been defensive.
In contrast, the dividend yield on the S&P ASX200 Index at 4.55% (before franking credits), is broadly in-line with the average yield over the past 10 years and near the middle of the 4.0-5.0% dividend yield range. In essence, over the past decade the interest derived from term deposits has been more unpredictable, and lower, than the dividends derived from a broadly diversified portfolio of Australian companies.
This does not imply that term deposits should be avoided. They may well be justified in a diversified portfolio. Careful consideration however needs to be given to the role they are intended to serve, and the possible unintended consequences of being defensive, particularly in the context of longevity risk.
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