Term Deposits in 2020: A Complete Guide
When it comes to investments, there are lots of options to choose from and plenty of acronyms to learn – stocks, bonds, GICs, TFSAs, RRSPs and more. All these types of investments can help you grow your money. The one that’s right for you depends on your short-term, long-term or even interim goals.
Before selecting any type of investment, we recommend you speak with an advisor. They can walk you through what type of investment makes the most sense for you and your situation.
Whether you're looking to start investing, diversify your portfolio, save for a down payment or just earn more interest than a savings account alone, term deposits can help you achieve your financial goals. They are a safe and secure investment with very little risk. You set the amount, your financial institution sets the interest rate, and you both decide when you get to cash out with your return. The great thing about a term deposit is that you can use it for both long-term and short-term needs.
Let’s explore them a little more. This guide is designed to give you a comprehensive understanding of term deposits and some ideas of how you could incorporate them into your financial plan.
What is a term deposit and how does it work?
A term deposit is a cash investment you make with a financial institution that typically has a guaranteed return at a fixed interest rate over a set period of time (the term). Although originally term deposits and Guaranteed Investment Certificates (GICs) were technically different, they’ve come to be interchangeable and mean the same thing.
A term deposit can come in two forms: redeemable, which means you don’t have to wait until the complete end of the term to take out your money, and non-redeemable where your money is locked for a fixed period of time. Depending on the term deposit, interest can be paid to you annually, at the end of the term or sometimes even monthly.
Types of term deposits
Term deposits come in all shapes and sizes. Here are the main features you'll want to look for to find the right term deposit:
Short-term vs. Long-term deposits
Depending on your goals and your financial plan, you can invest in a term deposit with terms ranging from one month to five or more years. Short-term deposits will tend to have lower interest rates than longer-term ones.
Redeemable vs. Non-redeemable term deposits
The difference between redeemable and non-redeemable term deposits is straight-forward. You cannot redeem non-redeemable term deposits without incurring penalties whereas you can generally take out redeemable term deposits before the end of their term.
However, make sure you pay attention to the conditions surrounding redeemable term deposits. There might be certain stipulations. For instance:
- It might take 30 days or more before you have access to your funds
- You might only be able to redeem them on the anniversary date (e.g. after the first year of a three-year term)
- You might not get the full rate if you redeem early, but instead an early redemption rate
There are other possible conditions, so make sure you read the fine print or ask your financial advisor before you deposit in a redeemable term deposit if you want access to your money.
Meanwhile, some term deposits are completely cashable, meaning that at any point during the term, you can take them out with no fees or penalties, along with whatever interest you've earned. Again, because of their flexibility, redeemable term deposits will tend to have lower interest rates than non-redeemable ones.
Understanding whether your term deposit is a redeemable, non-redeemable or fully cashable term deposit is essential based on your goals. If you’re parking your rainy day fund in term deposits, you'll want them to be liquid (readily available), so you can access your money in case of an emergency. If you're using them to build up your emergency fund or save for a purchase you know is five years away, there's less need for them to be accessible.
Special term deposits
There are other kinds of term deposits available too. You could get a prime-linked term deposit, where the interest rate is not fixed but changes along with the prime rate. This gives investors a great opportunity to lock their money in while taking advantage of the interest rate environment. If the prime rate goes up, so does the rate on your deposit.
Another popular form of term deposit is a market-linked term deposit or index-linked term deposit. These are tied to securities that historically have performed well. They tend to give investors a minimum guaranteed return, or at the very least protect their principal, with the potential for significantly greater returns (up to a maximum) based on the performance of the market.
You can also get a tiered interest term deposit. These tend to be fully redeemable products you can cash out at any time, but the interest is broken up over the course of the term. In the first six months, for example, you’ll earn a much lower interest rate than in the next six months. These term deposits are designed to give you the flexibility to access your money at any time, while rewarding you for keeping it deposited over a longer period.
Are term deposits safe?
When people ask whether term deposits are safe investments, they typically want to know if they can count on their money being there at maturity.
Generally, term deposits aren't affected by the market with certain exceptions like index-linked terms. They're not like mutual funds where you have a diversified portfolio and you're banking on the combination of aggressive and conservative investments along with time in market to grow your money.
With a term deposit, you place your money with a financial institution, and that financial institution then uses those deposits to provide loans to others. The interest the loans generate is what helps to pay interest on your term deposits. Therefore, your principal and your rate of return are both guaranteed. Even if the interest rate on the term you deposited changes prior to maturity – something that can happen at any time – you will earn the original rate you got on the day you made your deposits. The exception to this is if you have a term deposit with a variable rate, in which case you're hoping the interest rates go up more than they go down over the course of the term. That's why term deposits are considered safe, conservative, short to medium-length investments and a great way to diversify your portfolio.
Pros and cons of term deposits
The rule of investing is generally the safer the investment, the lower the return (also the shorter time in market, the lower the return). With the safety of a term deposit, you sacrifice higher potential rates of return, but your money is generally safer.
When you compare a term deposit to a High Interest Savings Account, a term deposit tends to have higher rates, but the savings account boasts the flexibility of access to funds. With the term deposit, you're also locked into the rate you got when you made your deposit (with the exceptions already mentioned above), whereas the interest rate on your savings account can change at any time.
Something else to keep in mind is that term deposits are taxed at a higher marginal tax rate. Whenever possible, use available tax shelters like your RRSP, TFSA, RRIF, RESP or RDSP. Not all term deposits are available with every registered plan, so make sure you check with your advisor.
Related reading: Complete guide to TFSAs
Term deposit strategies
As we saw when comparing term deposits to savings accounts, one of the places savings accounts tend to have an edge is with liquidity (having easy access to the money in the account). One of the ways experienced investors deal with this issue is by laddering their term deposits. Instead of all the term deposits maturing at the same time, different ones mature at different times.
Start by dividing your money into five equal parts and invest each in a term deposit from 1 to 5 years.
When your first term matures a year from now, reinvest those funds in a 5-year term. Repeat this process year-after-year so every year, you have a term deposit maturing.
Are term deposits worth it?
Term deposits will generally give you a better rate of return than a savings account and a much better rate than a chequing account. If you're parking money for an emergency fund or for a vacation in the next couple of years, a term deposit is a great option.
The market boasts the promise of higher rates, but not without risk. Any investment you make, whether in stocks, bonds, mutual funds, ETFs, etc. will ride both the ups and the downs of the market. The greater the potential return, the greater the risk. So, the market may not be the best place to grow your money in the short term.
With a term deposit, your rate is locked and your returns are guaranteed. If you're saving for a down payment in the next five years, a term deposit is a great tool.
View our current term deposit offers here — $500 is all it takes to get you started and there are no maximum deposit limits!
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