Index fund or term deposit?
June 14, 2011 11:27 PM Subscribe
Can someone shed some light the differences between term deposits and index funds in Australia? That is, what's best for me?
I've been working for a few years, but generally live fairly cheaply and have been building up money in an online 'netsaver' account at about 3.5% interest. I've then put the bulk of that ($40,000) into a term deposit for 7 months at 6% interest.
I've been reading about index funds and they seem perfect - low fees, decent returns, and (most importantly for me) very little fuss. When I look at specific index fund sites (Vanguard Australia, for example) the funds all seem to have returns of 1-4 %.
I guess my question is - are these returns just part of the normal fluctuations, and that it would be wise to invest in index funds now and then let them sit for some time? If so, does anyone have any recommendations for a good index fund? Or is it better to keep everything in a term deposit for as long as it has a better interest rate?
I'm looking for something long term, and will be happy to put this away for ~ 5 years.
(I understand that past performance isn't a predictor of future performance, and that you're not my financial advisor)
I've been working for a few years, but generally live fairly cheaply and have been building up money in an online 'netsaver' account at about 3.5% interest. I've then put the bulk of that ($40,000) into a term deposit for 7 months at 6% interest.
I've been reading about index funds and they seem perfect - low fees, decent returns, and (most importantly for me) very little fuss. When I look at specific index fund sites (Vanguard Australia, for example) the funds all seem to have returns of 1-4 %.
I guess my question is - are these returns just part of the normal fluctuations, and that it would be wise to invest in index funds now and then let them sit for some time? If so, does anyone have any recommendations for a good index fund? Or is it better to keep everything in a term deposit for as long as it has a better interest rate?
I'm looking for something long term, and will be happy to put this away for ~ 5 years.
(I understand that past performance isn't a predictor of future performance, and that you're not my financial advisor)
Use cannex or ratestar to find the best netsaver account - the rates they're offering are as good as your term deposit. Ubank (an nab offering) is offering 6.01% or 6.51% if you can arrange for regular deposits (say automated deposits from your work payslip, for that low-fuss feel). Then just check and compare term deposit and netsaver rates every six months to make sure you're still getting a good deal. If index funds look to be getting better returns in the future, you can always switch over - but then you're gambling on whether the stock market will go up or down, and you have to cover management costs of around 1%.
You could get up to 7.12% in term deposits with 5 year maturity, if you were happy with locking it away that long.
And the usual government bonuses: super co-contribution can be $1000 per year, first home owner account is $850 for each $5000 you put in (but you must spend it on buying a house you live in, etc) and if you're on Centrelink payments they have a savings match plan up to $500, which are all decent returns if you meet the requirements and can do the paperwork.
posted by quercus23 at 1:01 AM on June 15, 2011
You could get up to 7.12% in term deposits with 5 year maturity, if you were happy with locking it away that long.
And the usual government bonuses: super co-contribution can be $1000 per year, first home owner account is $850 for each $5000 you put in (but you must spend it on buying a house you live in, etc) and if you're on Centrelink payments they have a savings match plan up to $500, which are all decent returns if you meet the requirements and can do the paperwork.
posted by quercus23 at 1:01 AM on June 15, 2011
Unless the depositing institution goes bust, you will never lose money with a term deposit. But an index fund could very easily be less worth than what you put into it at any given time, depending on the movement of the index. If you had the misfortune to be in index funds when the global financial crisis struck, you would have lost a great deal of money.
The return you see quoted for an index fund is the amount by which the value of the units in the fund has increased over the time scale measured. It does not represent interest paid like the returns you see quoted for term deposits. The value of units in an index fund can go down as well as up, whereas your term deposit is always and forever the dollars you put in + the interest paid.
Over a very long time scale, and making regular deposits (look up "dollar cost averaging") you could probably make a better return on index funds than by reinvesting in term deposits with banks, but you will not have the same security if you value being able to rely on having X dollars around at any given time.
posted by i_am_joe's_spleen at 3:05 AM on June 15, 2011
The return you see quoted for an index fund is the amount by which the value of the units in the fund has increased over the time scale measured. It does not represent interest paid like the returns you see quoted for term deposits. The value of units in an index fund can go down as well as up, whereas your term deposit is always and forever the dollars you put in + the interest paid.
Over a very long time scale, and making regular deposits (look up "dollar cost averaging") you could probably make a better return on index funds than by reinvesting in term deposits with banks, but you will not have the same security if you value being able to rely on having X dollars around at any given time.
posted by i_am_joe's_spleen at 3:05 AM on June 15, 2011
The stock indexes like the Dow Jones Industrial Average, or the S&P 500, are simply concatenations of the values of a group of stocks. In the case of the DJIA, it is a mere 30 stocks. Granted, it is probably the 30 best companies, but it is still just 30. The S&P 500 is 500 stocks.
They have a recipe for what the components are. It might be 3 shares of Cisco, 5 shares of McDonalds, 2 shares of IBM.
An index fund is a mutual fund. (Very simply, an investment account owned by a bunch of people.) What it does is purchase stocks in the same ratios as whatever fund it is shadowing. If the DJIA goes up 10%, the value of your account goes up 10%.
They are a good part of an investment strategy, but they aren't "savings" in that you can lose principal.
The returns will likely be better than just the stated gains of the average because of dividends. (Dividends are your share of the profits of that company for the time period based on your percentage ownership in that company. They are usually stated as a percentage of the share price.) So even if the index remains flat, the dividends paid will make your gains positive.
Friendly advice: index funds are meant to be long term holds. If you bought an index fund 5 years ago, you are probably just breaking even. If you bought 10 years ago, you are probably doing ok.
So, if you want to save for the short term and regular bank interest isn't enough for you and you'd like to take on a little more risk in exchange for a little more payback, you might want to consider one of the "capital preservation" funds. They choose their own grouping of stocks based on low risk, steady growth and dividend payout, with the intent that a dollar parked in that fund will maintain the value it had when you deposited it. They are a sort of hedge fund (in the classic sense, not the legal sense). If the market skyrockets, you may not make all the gains, but if it drops, their goal is that your money stays relatively safe.
If you don't want to think about it, stick with the 3.5% CDs you are buying. That is not a bad rate of return and you have almost no risk.
posted by gjc at 6:04 AM on June 15, 2011
They have a recipe for what the components are. It might be 3 shares of Cisco, 5 shares of McDonalds, 2 shares of IBM.
An index fund is a mutual fund. (Very simply, an investment account owned by a bunch of people.) What it does is purchase stocks in the same ratios as whatever fund it is shadowing. If the DJIA goes up 10%, the value of your account goes up 10%.
They are a good part of an investment strategy, but they aren't "savings" in that you can lose principal.
The returns will likely be better than just the stated gains of the average because of dividends. (Dividends are your share of the profits of that company for the time period based on your percentage ownership in that company. They are usually stated as a percentage of the share price.) So even if the index remains flat, the dividends paid will make your gains positive.
Friendly advice: index funds are meant to be long term holds. If you bought an index fund 5 years ago, you are probably just breaking even. If you bought 10 years ago, you are probably doing ok.
So, if you want to save for the short term and regular bank interest isn't enough for you and you'd like to take on a little more risk in exchange for a little more payback, you might want to consider one of the "capital preservation" funds. They choose their own grouping of stocks based on low risk, steady growth and dividend payout, with the intent that a dollar parked in that fund will maintain the value it had when you deposited it. They are a sort of hedge fund (in the classic sense, not the legal sense). If the market skyrockets, you may not make all the gains, but if it drops, their goal is that your money stays relatively safe.
If you don't want to think about it, stick with the 3.5% CDs you are buying. That is not a bad rate of return and you have almost no risk.
posted by gjc at 6:04 AM on June 15, 2011
I disagree with gjc that 3.5% is a good rate of return. If you're taxed on those interest earnings at 30%, you're losing money to inflation of 3%.
posted by quercus23 at 6:02 PM on June 15, 2011
posted by quercus23 at 6:02 PM on June 15, 2011
Response by poster: Thanks everyone. I presume a CD is the same as a term deposit - mine is earning interest at 6%, though I'll be paying > 40% interest on that.
At this stage I think I'll put a bit into a few index funds, and keep part in term deposits, and see where each of them are at in several years time.
posted by twirlypen at 7:09 PM on June 15, 2011
At this stage I think I'll put a bit into a few index funds, and keep part in term deposits, and see where each of them are at in several years time.
posted by twirlypen at 7:09 PM on June 15, 2011
"CD" (Certificate of Deposit) is a US term for something very like what we call term deposits. I'd be careful about just assuming American writing on them applies, eg rules on government guarantees are different between the US and Australia.
I assume gjc is American, and that's also why gcj's view of what's a good interest rate is different.
posted by i_am_joe's_spleen at 7:41 PM on June 15, 2011
I assume gjc is American, and that's also why gcj's view of what's a good interest rate is different.
posted by i_am_joe's_spleen at 7:41 PM on June 15, 2011
Know I'm a bit late to the game, but I've done a lot of research into different investments in Australia, so I thought I would chime in.
I think you are doing the right thing by putting most of your cash in term deposits; 6.4%, the market cash rate in Australia, is very good, and there is basically no risk. The stock market, returns on average about 11% over a very long period (e.g. 20 years). However, in the short term, it is very risky, especially at this point. There are a lot of reputable commentators who have suggested that over the next few years, the market may go up, but then go back down again. Note that there are also commentators who believe stocks will only go up. Whoever you choose to believe, if you go with stocks, a -20% return is a distinct possibility.
That said, if you are saving for retirement, and have a 20 year time frame, then maybe that doesn't bother you. This would be the standard financial planner advice as well, by the way.
In terms of index funds, I think Vanguard is a good choice (they are very well respected in the index fund world). You might also consider an exchange traded index fund, like the Spyders STW fund. This is a little more complicated to set up, but also gives you the option to buy in and sell out at a moment's notice.
I personally prefer alternative investments to buy and hold stocks. However, these are orders of magnitude more complicated. If you're not really interested, I would not recommend it. I think the index fund approach is probably the most reasonable for everyday investors.
Also, I'm not sure if you meant to say you're paying 40%+ tax on your investment income? If so that is a lot! Is this cash for retirement? If so, put it in super. Is this savings for a home deposit? Put it in one of those first home saver accounts. Do you have anyone else (a spouse or child) whom you trust and who is on a lower income tax bracket? Try to come to an agreement (in writing preferably) to have them earn the interest. Finally, do you have a home loan? If so, possibly the best place to put your spare cash is on the home loan. You will effectively be "earning" the highest cash rate available, and it will be tax-free.
A lot to consider, but I hope this helps. Good financial advice is hard to get these days, but you're on the right track getting information. All the best!
posted by strekker at 11:35 PM on July 17, 2011
I think you are doing the right thing by putting most of your cash in term deposits; 6.4%, the market cash rate in Australia, is very good, and there is basically no risk. The stock market, returns on average about 11% over a very long period (e.g. 20 years). However, in the short term, it is very risky, especially at this point. There are a lot of reputable commentators who have suggested that over the next few years, the market may go up, but then go back down again. Note that there are also commentators who believe stocks will only go up. Whoever you choose to believe, if you go with stocks, a -20% return is a distinct possibility.
That said, if you are saving for retirement, and have a 20 year time frame, then maybe that doesn't bother you. This would be the standard financial planner advice as well, by the way.
In terms of index funds, I think Vanguard is a good choice (they are very well respected in the index fund world). You might also consider an exchange traded index fund, like the Spyders STW fund. This is a little more complicated to set up, but also gives you the option to buy in and sell out at a moment's notice.
I personally prefer alternative investments to buy and hold stocks. However, these are orders of magnitude more complicated. If you're not really interested, I would not recommend it. I think the index fund approach is probably the most reasonable for everyday investors.
Also, I'm not sure if you meant to say you're paying 40%+ tax on your investment income? If so that is a lot! Is this cash for retirement? If so, put it in super. Is this savings for a home deposit? Put it in one of those first home saver accounts. Do you have anyone else (a spouse or child) whom you trust and who is on a lower income tax bracket? Try to come to an agreement (in writing preferably) to have them earn the interest. Finally, do you have a home loan? If so, possibly the best place to put your spare cash is on the home loan. You will effectively be "earning" the highest cash rate available, and it will be tax-free.
A lot to consider, but I hope this helps. Good financial advice is hard to get these days, but you're on the right track getting information. All the best!
posted by strekker at 11:35 PM on July 17, 2011
This thread is closed to new comments.
What do you think is going to happen to the Australian stock market over the next five years? I don't have a clue.
posted by wilful at 11:49 PM on June 14, 2011 [1 favorite]