Martin Hawes: Deposits are an important tool

Martin Hawes

I have heard people say over the years that bank deposits are for wimps.

They say the bank will only pay interest of 3 or 4 per cent which means they are hardly a proper investment.

If you have your money in a bank, you will never become wealthy, but are doomed to poor returns and poverty.

While there is some truth in it, there are also some basic misunderstandings. Bank deposits have their place and, in some instances, can't be beaten as an investment.

Bank deposits have three main uses: the first is for short-term savings. If you are saving for something in two or three years' time, such as a car or deposit for a house, you have no option - short-term bank deposits are the only way to go.

Many people lose money because they get their duration wrong - for example they go into an investment such as shares or property, need their money and sell out early.

The volatility of these investment types is such that there is a reasonable chance the early sale will be at a poor time, resulting in a loss.

The good thing about bank deposits is they have low volatility - you can be sure your money will be there when you want it.

The second use of bank deposits is to hold funds when markets do not seem favourable. Being heavily invested in bank deposits can be quite an aggressive strategy - you are making a call that markets are over-valued and by waiting you will be able to buy in cheaply in the future. In this respect, there is nothing wimpish about bank deposits.

The third use is to have an emergency fund. This is important for everyone but especially for those who are using their investment capital to live on - usually older people.

A good amount of cash in the bank can tide you over when your other investments are not giving good returns. The cash holdings mean you do not have to sell out of the markets when times are bad - almost always at a loss - but can ride out the downturn.

But people sometimes go to the safety of bank deposits when they should be in better returning investments. Long-term investors should tolerate the volatility of shares and property and invest heavily in these for the better returns they eventually provide.

No one has ever used bank deposits as a means of becoming wealthy, but plenty of people have lost serious money because they have used some other investment type for their short-term money.

* Martin Hawes is a financial adviser. His disclosure statement can be found at www.martinhawes.com