Investment deposits...worth some interest
An ongoing challenge intermediaries face is maximising the return on the cash portion of a portfolio without taking on risk. For high yielding returns that are also guaranteed, consider an investment deposit.
An investment deposit would typically make up a portion of the cash segment of an investor’s portfolio. It is a yield enhancing investment, sometimes called a yield sweetener, placed at a bank for a period of time. It is similar to normal deposits and considered low risk, but offers attractive yields high enough to enhance an investor’s portfolio.
The options include call, fixed and notice investment deposits. Call investment deposits are available on demand and thus usually carry a lower interest rate. Fixed investment deposits, ranging from one to 12 months, have a set maturity date and fixed interest rates whilst notice investment deposits, with notice periods typically between 32 to 120 days, will only approach maturity once notice is given by the investor.
Benefits to the client
Investment deposits are easy to understand, offer high yields and the rate quoted is guaranteed once locked in, irrespective of what happens to the repo or prime rates. For this reason, fixed investment deposits are an easy way to protect your client from interest rate risk.
Notice investment deposits work slightly differently, in that either the bank or the investor has to give the relevant notice before any changes can be made. If prime had to decrease, an investor would be protected from that decrease by the notice period. Notice deposits are beneficial for investors who believe the interest rate cycle is going to turn, since although there is a lag effect, yields would eventually move relative to movements in prime.
Interest rates
Interest rates for investment deposits are quoted either as nominal rates (NACM) or annual effective rates (NACA). The NACM is the actual interest earned over a one month period. The NACA is the effective interest rate earned (at the same nominal rate) for one year. This implies that the investor also receives the compounding effect by earning interest on interest throughout the life of the investment. The NACA is therefore always more than the NACM.
It is extremely important to understand the difference between the two types of rates to avoid being caught out by shrewd advertising campaigns. For example a nominal interest rate of 6.98% on an investment is actually a superior investment compared to a product offering an annual effective (NACA) rate of 7.15%.
Money market funds vs. investment deposits
The fundamental difference between money market funds and investment deposits is that the rates quoted for money market funds are based on retrospective or historic yields, whilst investment deposit rates are prospective and future-oriented.
With a typical money market fund the yields that will be earned are uncertain. With investment deposits the actual rate earned, as well as the interest income, is known and guaranteed.
Benefits to advisors
Investment deposits allow advisors to offer a yield booster for a client’s portfolio with short durations. This means advisors can protect clients who are wary of volatility in the stock markets or other derivative products. Advisors can also guarantee the interest rate going forward which makes it an attractive product for clients. Advice fees are also payable by some institutions.
The role of the financial planner is to optimise the client’s yields by determining the client’s cashflow requirements and matching these to the maturity cycle of the investment deposit.
