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 guaranteed secure investments 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 term deposits is that you can use them for both long-term and short-term needs.
Let’s explore: this article is designed to give you an overview of term deposits and some ideas of how you might incorporate them into your financial plan.
What is a term deposit and how does it work?
A term deposit is a cash investment with a guaranteed return at a fixed interest rate over a set period of time (the term). You’ll also encounter the term Guaranteed Investment Certificates (GICs), which are basically the same thing as term deposits.
A term deposit can come in two forms: redeemable, which means you don’t have to wait until the 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 type of term deposit you purchase, interest can be paid to you annually, at the end of the term or sometimes even monthly.
Types of term deposits
Short-term vs. long-term deposits
Depending on 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 terms.
Redeemable vs. non-redeemable term deposits
The difference between redeemable and non-redeemable term deposits is straight-forward. You can’t cash-in a non-redeemable term deposit without incurring penalties, but you can generally cash-in redeemable term deposits before the end of their term. Make sure you pay attention to the conditions surrounding redeemable term deposits. 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 if you anticipate needing access to your money, ask your financial advisor before you purchase a redeemable term deposit.
Some term deposits are completely cashable, meaning that at any point during the term you can redeem them with no fees or penalties, along with whatever interest you've earned. Because of their flexibility, redeemable term deposits will tend to have lower interest rates than non-redeemable term deposits.
Understanding whether your term deposit is a redeemable, non-redeemable or a 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 save for a purchase you know is five years away, you can keep your money working for you by locking it in to a longer term deposit with a higher rate. Often, this long-term strategy can be used to “purchase an income” in retirement for yourself or a family member.
Special term deposits
You can 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 guaranteed investment certificate (MLGIC). These are tied to a defined basket of securities that historically have performed well. They often protect the investor’s principal investment and offer a minimum guaranteed return with the potential for significantly greater returns (up to a maximum) based on the performance of the market. Think of it as having a stable floor, and potentially a high ceiling. MLGIC’s usually have a theme to them, such as focusing on an industry, exclusively national, international, emerging-market stocks, or more recently, responsible investing. Let’s explore that a little more.
Responsible Investing and Term Deposits
Responsible Investing incorporates environmental, social and governance (ESG) factors into your term deposit strategy. These products invest in stocks and bonds with brands that value sustainability, human rights, good working conditions, employee diversity, resource conservation and other factors. These brands are constantly vetted by fund managers, who are active shareholders and represent your interests inside the company, giving you a vote and a voice.
For example, the winwin EarthLink™ GIC is a market-linked GIC where the stock portfolio is vetted using ESG criteria and focused on top-performing companies that also have demonstrated environmentally conscious practices. It offers the same benefits as a typical MLGIC (protected principal, minimum guaranteed return and maximum potential return) with the added bonus of enabling investors to align their capital with their values.
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. The combined rate will give you a competitive return overall. 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?
With the exception of prime-linked and market-linked terms, term deposits aren't negatively affected by the market. Even with those types of terms, your potential maximum return may be impacted, but your initial investment is protected. 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.
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 secure, 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 gives effortless 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), while the interest rate on your savings account can change at any time.
Remember that term deposits are taxed at a higher marginal tax rate, so you can use available tax shelters like your RRSP, TFSA, RRIF, RESP or RDSP. Not all term deposits are available with every registered plan, so 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 five-year term. Repeat this process year-after-year so every year, you have a term deposit maturing, and you can weigh your options against your circumstances at that point.
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 most term deposits, 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.
Advice you can bank on
Our financial advisors have the expertise and experience to help you create a financial plan that’s based on your individual circumstances and that helps you reach your personal financial goals. Take the first step towards understanding your financial picture and book an appointment with an advisor today.