An Understanding of a Significant Banking Service
One of the perks of knowing the various banking services available is that you can make more money on savings and investments. Aside from savings and checking accounts, another type of deposit account is called the term deposit account. In this article, we'll cover term deposits, its benefits and how to choose one.
What is a Term Deposit?
A term deposit is an investment set for a fixed period ranging from months to years. Once you've made a term deposit, you can only withdraw it once it's mature, after the set term. Term deposits range across different levels and have varying minimum deposit amounts.
When you decide to invest in a term deposit, the bank guarantees the return of your capital and the set interest on it. A bank's rate on term deposits is independent of the Federal Reserve. Hence you'll find varying rates across different banks.
Term deposits are low-risk but may not be a good fit for you. Understanding the features and benefits they offer will help you make the right conclusion on how right it is for you.
Features of a Term Deposit
Term deposits have three distinct features: a set duration, fixed interest and a "no withdrawal until maturity" rule. A certificate of deposit (CD) is the most common term deposit.
Term deposit rates are usually higher than the interest rates for other deposit types. Usually, the highest annual percentage yield (APY) that you can earn from a savings account is 3 to 3.5%. But APYs on a 1-year certificate of deposit can reach as high as 4.5%. Term deposit interests are usually higher with increasing investment duration.
However, there's one exception to the no-withdrawal rule of term deposits. Some term deposits allow for withdrawals without penalties; this type of CD is called a no-penalty CD. It allows you to withdraw your funds without paying a fee before the agreed term ends. However, this comes with a catch. No-penalty CDs earn less interest than regular ones.
Benefits of Term Deposits
Term deposits come with several benefits, including the following:
Term deposits provide fixed rates over investments from a few months to a few years. Investors who want a guaranteed return on investments in addition to their initial capital will find term deposits very suitable.
You'll find different time offers from 3 months, 6 months, 1 year, to 5 years. These terms have different interest rates and can be withdrawn or non-redeemable during the term, depending on the type chosen. You can secure term deposits via a tax-free or retirement savings account.
If you're curious how a financial institution can pay fixed interests on term deposits, here's how it works. After gathering a pool of capital from various investors, the bank invests the money in certain assets with a guaranteed return over investments.
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So if your bank is paying 3% APY for your term deposits, they could invest in assets that pay 7% APY; that way, your bank will be able to cover all expenses, pay their users and still land a profit. Term deposits are a safe investment option, and there's a possibility your bank will have a challenge paying back.
Low Minimum Deposit
Some investments require thousands of dollars to qualify, but you need a few hundred dollars to sign up for a term deposit. In addition, term deposits are perfect for you if you want to achieve a short to medium-term investing goal. You can use short-term deposits of 30 to 270 days or longer-term ones of 1 to 5 years.
How to Calculate Interest on Term Deposits
If you invest $10,000 into a 1-year term deposit with a 3% interest rate, you can use the following formula to know the exact interest you will make.
- Deposit amount x interest rate (%) x number of years for the investment.
- Hence, $10,000x 3% x 1 equals $300 interest.
Here's the formula to calculate the exact interest rate you will receive for using a term deposit account for a few months.
- Annual interest percentage/365 = daily interest rate
- Daily interest rate x number of days for the term deposit investment= specific interest rate for investment duration
For example, if you're investing $1000 for three months in a term deposit account offering 2.5% APY, the interest rate will be as follows:
- 2.5/365= 0.00685.
- 0.00685 x 90 = 0.62%.
Hence, you'll be getting 0.62% on your investment for three months.
How to Choose a Term Deposit
You should consider some important factors before choosing a term deposit. We've collated the top things you should consider to get you started.
What is the interest rate, and how is it paid? Is the rate high or low? Would you get paid monthly, yearly or at maturity?
What are the available time frames for investment? Three months, nine months, two years, five years?
What's the minimum deposit amount required? And how does the interest rate change with the amount you're willing to invest? Do they raise the interest rate with increasing deposit amounts?
What fees are charged to open an account? Peradventure, you wish to discontinue your investment; what's the penalty fee? How big is it?
The Bottom Line
When you invest in a term deposit account, your funds are locked up for some time. Upon maturity, you receive your capital, including the accrued interests. Term deposits are right for you if you prefer low-risk investments for a short or long-term investing goal.
What does the term time deposit mean?
A time deposit is another name for a term deposit, and it represents a type of deposit where you invest a certain amount of money in receiving a fixed interest after some time. The caveat here is that you can't redeem your funds until maturity.
What are the risks of term deposits?
Aside from the fact that you can't access your funds until their maturity, you cannot add more money to your initial term deposit. If you wish to invest in a term deposit, it must be new.