What exactly is a term deposit, and how does it work? We’ve put together a guide to understanding all things term deposit – that includes how they play into your financial plan and how they differ from other types of investments.
Term deposits in a nutshell
Term deposits are products designed to help you grow your savings. When you deposit your money into a term or Guaranteed Investment Certificate (aka GIC – different name, same product) you set it aside for a specific length of time or ‘term’ and in return, you get a higher interest rate than a standard savings account. A term length can be anywhere between 30 days to 5+ years. Usually, the rule is, the longer your money is in the term, the higher your interest rate is. The interest pays out to you on the day it ‘matures’ or when the term is over
For example, if you put away $10,000 into a term deposit at 2.7% interest for a 12-month term, you’ll end up with $10,270 after the 12 months. That’s an extra $270 you wouldn’t have made if you had kept it in a standard chequing account. And thanks to the power of compound interest, you can build wealth by earning more interest on the interest you make. You work hard for your money. So your money should work hard for you.
Another type of term deposit is called an index-linked or market-linked term deposit. These work the same as a traditional term deposit…kinda. You’re still guaranteed the principal plus a return. However, the interest on the return depends on how the market performs. Basically, when the term deposit matures, the interest you’ll be paid out depends if the stock market did well or not so great.
When you’ll get your money back
In most cases, if your money is in a term deposit, you can’t access the funds before the agreed term or duration. In return, you’ll get a guaranteed rate of return over that term. Redeemable term deposits are available, but the rates usually aren’t as high as locking into a non-redeemable term. The interest rate is paid out to you on the maturity date of your term deposit. Maturity is basically a term deposit birthday, except instead of getting a slice of cake to celebrate, you’ll get a nice return in the form of interest. Now, that’s a present we can get behind.
How they’re different from other investment types
We like to think of savings in three separate boxes – the short-term box, the medium-term box, and the long-term box.
In your short-term box, you’ll want to keep 3-4 months of contingency savings – that’s your savings account.
Your long-term box is usually for events in 7+ years. It’s typically for retirement investments, like mutual funds, ETFs, and registered savings.
You also need a medium-term box to address the ‘everything-in-between’. That includes things like putting funds aside for things like a vacation, a new car or even the down payment on a home. Term deposits are a great option for these medium-term financial needs because they’re tied to a specific length of time that you have control over.
How to tell which one is right for you
The great thing about term deposits is that your investment is guaranteed. But you need to time manage your financial plan. Because you can get penalized for withdrawing funds from a non-redeemable term deposit before its maturity date. Be sure you don’t need the funds for a certain length of time.
Another great feature of term deposits is that they’re flexible. You can incorporate them into your RRSP portfolio, as well as other registered products like RESPs, TFSAs, and RRIFs.
P.S.: You can use term deposits for long-term goals as well. They can add diversity to your investment portfolio and since they’re guaranteed, they are a more conservative investment option than mutual funds.
Be sure to read the fine print
It’s important that you read any disclaimers so that you know exactly where you stand on several issues. Even if you’re a term deposit pro, terms can change. You don’t want to be left in a sticky situation. Keep in mind things like maturity conditions and early withdrawal penalties.
Also, be clear about the rules for an automatic renewal of the term deposit. In some cases, your term deposit might be set up to reinvest when it matures if you don’t let your financial institution know you want to cash it.