Despite the attractive interest rates of term deposits, investors should be wary of the pitfalls of these investment vehicles, bond managers have warned.
Five-year term deposits are currently offered at rates close to 7 per cent per annum, but fixed interest managers said investors should consider all options before committing their money for such an extensive period of time.
"Term deposits don't give you optionality; in terms of an unexpected event you don't get the upside," UBS Global Asset Management head of fixed income Anne Anderson said at the Morningstar Investment Conference last Friday.
While a number of financial planners have said their clients were put off by the volatility in bond funds and preferred the stable returns of term deposits, Anderson said that over the long-term bonds would give better returns.
"Clearly the volatility of bond funds stir investments from time to time, but if [investors] stay the course - and we are not talking about investing for a month, we are talking about investing for 5 years - you will always get superior returns from a properly diversified bond fund," she said.
Colonial First State Global Asset Management co-head of fixed interest and credit Warren Bird rejected the idea that volatility in bond funds was hard to explain to clients.
"Bonds have a known rate of maturity. The fact that the price fluctuates along the way is just volatility, it is not ever permanent loss of capital," he said.
"If you go into the market today, I can tell with about 95 per cent confidence what the return of that fund will be in five years. The volatility side should be easy to explain."
Bird did not deny that term deposits were appropriate for some investors, but said investment decisions should be based on actual facts and not on ill-informed perceptions of bond performance.
Anderson said that if investors did want to get out of a term deposit in the case of an unplanned event, breaking a term deposit would come at a significant cost, with investors having to give up potentially 50 per cent of their returns.
She said an investment into term deposits also meant investors increased their risk profile.
"Australian banks are AA-rated, some of the best in the world, [but] who knows what the next five years brings? Should you have all your money with one Australian bank?" she asked.
