Jarden Wealth Weekly: Term deposits versus a balanced portfolio

Inflation touches every part of life, from necessities such as food and fuel to higher interest costs when borrowing money. Photo / NZME

OPINION

If you’re a reader of a vintage old enough to remember the 1970s and 1980s, you’ll grasp the significant impact that high inflation can have on investment decisions. However, for many investors today – particularly newer ones - dealing with high inflation is a new challenge.

Inflation touches every part of life, from necessities like food and fuel to higher interest costs when borrowing money. It means your budget, and how much you can dedicate to savings and investments, comes under pressure.

Between 2020 and 2023, we were in the highs and lows of the market cycle and the disorder of Covid-19 lockdowns. But it’s fair to say that financial well-being may have felt more attainable than it does today.

When inflation increases the prices of goods and services and erodes your purchasing power it can diminish the real value of money. So what options are there to protect wealth in a high inflation environment?

How about a term deposit?

Most people are familiar with term deposits, as they’re easily accessible through your bank. They’re like a savings account, and your money is locked in for a fixed time and with a fixed interest rate.

Term deposits are often favoured by risk-averse investors who view them as a safe haven. When inflation is high, so are the interest rates of term deposits which makes them appealing to many right now. But why do real interest rates matter? Let’s say the bank offers a term deposit rate of 6.10 per cent, but the latest inflation is 5.6 per cent. This means your actual earnings after considering inflation are only 0.5 per cent.

That said, it’s important to understand some of the risks. With a term deposit, your money is locked in for a set timeframe, and if you need to break the term, you’ll lose any interest plus you need to wait 31 days to have the money released to you.

Reinvestment risk is another consideration. When your term is up, reinvesting that money might now be at a lower interest rate – so lower returns. All of which means you could be missing out when compared to other investments that also offer greater flexibility.

Thought about a balanced portfolio?

A diversified 60/40 balanced portfolio is a more sophisticated approach to investment. It consists of 60 per cent equity and 40 per cent fixed income, with an average historical return of 8.8 per cent per annum over the past 94 years. (sources from Vanguard calculations, using data from Morningstar Inc.)

Despite this excellent potential, many investors shy away from this type of portfolio and people tell us this is because they’re worried about selecting the wrong companies or investing in the wrong asset classes. Plus, fluctuations in the portfolio value add a layer of complexity to the decision-making process.

Investors often ask: Why not lock in a good interest rate on a term deposit when it’s at 6 per cent per annum? It’s a good question, but we encourage people to think long-term and consider historic average rates rather than the shine of the current – rare – highs.

We analysed data comparing the performance of term deposits, bonds, and a balanced portfolio over an 18-year period from 2005 to 2023. The balanced portfolio outperformed term deposits in 12 out of the 18 years analysed.

The total return for the period (December 31, 2004, to June 30, 2023) was 232 per cent for a balanced portfolio, while term deposits yielded a total return of 161 per cent.

So what are the advantages of a balanced portfolio?

Financial experts can’t predict where the market will go, but most will advocate that choosing a mix of investments (for example a balanced portfolio) is a smart decision for the long run.

A balanced portfolio aims to spread out risk by investing in different types of assets, which helps cushion the impact if one isn’t performing as well. Gains in another area will often balance it out, meaning the portfolio overall is steadier, and geared towards long-term growth.

Right now, the financial markets are going through some ups and downs because of higher interest rates. We find those who stay the course with their investment plans in stocks and bonds withstand these challenges.

As the New Year approaches, many people take time to consider their financial goals for the year. There are no guarantees in investing, and all portfolios have their pros and cons, so it’s important to consider goals, focus on diversification and make an informed choice when navigating times of economic volatility.

- Steven Chang is a Wealth Management Adviser at Jarden.

Jarden Securities Limited is an NZX Firm. A financial advice disclosure statement is available free of charge at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement/.

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