Think about term deposits. What words or phrases come to mind? How do people often describe them? Safe. Secure. Low-risk. Guaranteed return... Today, we’re going to prove why these descriptions are problematic.
But first, let’s rewind 30 years to 1990. The year when East and West Germany were reunited after the collapse of the Soviet Union; the year Margaret Thatcher resigned as Prime Minister; and the year Nelson Mandela was released from prison in South Africa.
In this example, we’re going to pretend you were an employee in Australia who had enough money to retire comfortably in 1990. Your money was in a term deposit, with interest rates around 13.53%, which gave you $30,000 interest in your first year of retirement. Back then, $30,000 a year would have been considered a ‘comfortable’ amount for the first year of retirement. You also planned to live off the term deposit interest for the remainder of your retirement.
That 13.53% interest rate seems crazy, doesn’t it – given that interest rates are currently under 1%.
By 1991, just 1 year later, the term deposit interest income would’ve dropped, and you’d have received a return of $20,953. By the year 2000, ten years into your retirement, that income would’ve fallen to $9,313. And by 2020, it would’ve given you a measly $1,752 return.
Yes, these are annual income figures.
This is not to mention, of course, that 30 years later, the cost of living has doubled.
We often see people focusing on the lump sum they want to retire with. But what’s more important is the ongoing income stream they’ll be able to get from that amount instead.
What’s the alternative to a term deposit then?
If, in 1990, you had spread your money across the great companies of Australia (or the world), your income would be looking a lot different.
If you had enough money invested to receive dividends of $30,000 in the first year (the same amount as in the above example), 10 years later you would have received $41,600 (remembering that the term deposit would’ve given you $9,313). And by 2020, this figure would be at $126,000 – or four-fold the amount of the initial year.
You can see that you would be living a vastly different life.
Of course, you would have needed a larger sum to start with to receive the $30,000 in dividends than you did with the term deposit, but you can clearly see from the example what we’re trying to demonstrate as we compare term deposits to investing in the top companies of the world. Someone who was receiving those kinds of dividends in the 1990s is someone who got organised in the 1970s. With a bit of organisation and the correct strategies, you can reach your goals, too – and this is exactly what we love to help our clients achieve.
But what if I want to have some cash in a term deposit as something to fall back on?
Absolutely. We’re not saying not to do that. We’re just saying: keep it balanced. As a general guide, we recommend having enough in there to live off for 2 years, as a fall-back. With current interest rates at under 1%, that money is not there to make a return. It’s just there in case of emergency – such as a big (short-term) drop in the market.
Going back to the initial conversation about term deposits being ‘safe’ – obviously the people who say this are the same people who say investing in the sharemarket is risky. Everyone is entitled to their opinion, but you can see we are talking about facts here.
And the fact is, the interest of term deposits fell by 94% over a 30-year period. Does that sound like a safe option?
For more information, check out these two podcasts:
124: Own companies forever and live off the dividends
104: Retirement risks: purchasing power risk
Dallas Davison, Michael Hogue and Ali Hogue.