A term deposit is a type of investment that offers a guaranteed return over a set term or period of time. Let’s dive deeper into what a term deposit is, as well as its pros and cons. You’ll also learn how it compares to a demand deposit.
Definition and Examples of Term Deposits
With a term deposit, you choose to keep your money in a savings account for a term that may range from days to years. Generally speaking, the more you invest and the longer you’re willing to leave your funds untouched, the greater return you’ll receive.
The most common example of a term deposit is a Certificate of Deposit (CD). Unlike a traditional savings account, a CD requires you to lock away a lump sum for an agreed-upon term. While CD term lengths vary from lender to lender, they can be as short as three months and as long as 10 years.
In exchange for your commitment, you may earn a higher rate of return than you would with a savings account. In addition, a CD may offer some peace of mind because it is insured by the Federal Deposit Insurance Corporation (FDIC) up to the $250,000 legal limit.
- Alternate names: time deposit, fixed-term deposit
How Term Deposits Work
Term deposits have varying timelines. A term deposit of less than one year is considered a short-term term deposit. On the contrary, a term deposit of more than one year is known as a long-term term deposit.
Also, term deposits can be redeemable or non-redeemable. With a redeemable term deposit, you can access your money before the end of your term. If you opt for a non-redeemable term deposit, on the other hand, your money will be tied up until your term is over.
If you opt for a redeemable term deposit, be sure to read the fine print. With some lenders, there are caveats that may actually deter you from choosing a redeemable term deposit, including:
- You may have to wait 30 days or more before you can touch your money.
- You may only be able to cash in on your anniversary date.
- You might not get the full rate if you redeem early.
- A non-redeemable term deposit typically pays more interest than a redeemable term deposit.
Before you take out a term deposit, consult a CPA or tax professional to determine your tax burden.
Term Deposits vs. Demand Deposits
As stated, term deposits are deposits that are usually made for a few months to several years and reward you with guaranteed returns. If you’d like an investment product with greater liquidity, a demand deposit may be a better option. It’s essentially the same as a checking account. With a demand deposit, you can withdraw some or all of the money in your account whenever you’d like without paying a penalty or notifying the lender in advance.
One caveat of demand deposits, however, is that they offer lower returns than term deposits and may charge you various handling fees.
Pros and Cons of Term Deposits
Higher interest rates than a savings account
Safe investment products
You can earn greater returns with other products
The money is technically under lock and key
The money you make is taxable
- Higher interest rates than a savings account: Compared to a traditional savings account, a term deposit comes with a higher interest rate and yields a better return—but only if you’re willing to wait for the fixed time period to expire.
- Safe investment products: Since the market won’t take a toll on a term deposit like it would on mutual funds, for example, it’s considered a safe way to invest.
- Flexible: There are various types of term deposits you can choose from, including short-term term deposits, long-term term deposits, redeemable term deposits, and non-redeemable term deposits.
- You can earn greater returns with other products: While they’re riskier than term deposits, stocks, bonds, and mutual funds will likely yield higher rates of return.
- The money is technically under lock and key: Unless you go with a redeemable term deposit, which usually comes with some limitations, you won’t be able to take money out of the account until your term is over.
- The money you make is taxable: You’ll have to pay taxes on the interest you earn with a term deposit.
- A term deposit ensures the money you invest will earn a certain amount of interest over a set term or period of time.
- You can use a term deposit to save for any financial goal, such as paying for a house, car, or wedding.
- While a term deposit will likely offer a greater rate of return than a traditional savings account, you can earn more by investing in riskier products such as stocks, bonds, and mutual funds.