Are You Using Fixed Deposits The Right Way?
Malaysians like fixed deposits. We collectively placed around RM500 billion in fixed deposits in 2019; according to statistics from Bank Negara Malaysia. To put this figure into perspective, term deposits held by government, financial institutions, and corporations amounted to only RM450 billion.
While term deposits play a role in your financial plan, you shouldn’t rely on them for all of your savings and investing needs. Here are some things to keep in mind when using term deposits.
Don’t use fixed deposits for your emergency fund
Fixed deposits are not the right place to keep your emergency savings because they tie up your funds. If you withdraw your funds before the fixed deposit maturity date, you may only earn a portion of the interest, or none at all. How can you pay for an unexpected medical bill or auto repair if your funds are blocked for six to 12 months?
With an emergency fund, you need to prioritize liquidity over getting a high interest rate because you need to have access to the money at all times. Instead of keeping your emergency fund locked in fixed deposits, opt for a savings account or cash management wallet that gives you quick access to your money should the unexpected happen.
Don’t use fixed deposits for your long-term investments
You should not use fixed deposits for long term investments. Fixed deposits may seem secure because of the guaranteed rate, but keeping your excess cash in a fixed deposit account for three to five years (or more) also ensures that your money is compounded at a much lower rate than if you were investing. in a diversified account. investment portfolio during this same period.
The chart below shows how much additional wealth you would have over time if you invested your money instead of putting it in a fixed deposit.
The value of your money in a 2% fixed deposit account versus invested at 6% per year in 20 years
Assumption: Return on investments compounded annually
If you kept RM50,000 in a fixed deposit account that returned 2% every year, you would have RM 74,297 in 20 years. However, if you had invested that 50,000 RM in a balanced investment portfolio that brought in 6% each year, your cash flow would have grown to 160,356 RM in 20 years.
In other words, you would have earned RM86,059 more if you had invested your money in an investment portfolio instead of holding it in a fixed deposit for 20 years. In the long run, investing your money makes it grow exponentially through the power of compounding.
Here’s another way of looking at it: To get RM 160,000 in 20 years with term deposits, you will need to deposit RM 107,000 today. But you only need to invest RM 50,000 in the markets to reach the same amount in 20 years.
Even if you are risk averse, you shouldn’t stay completely out of the markets. The investment is not inherently high risk; you can invest in low risk portfolios that limit your downside in the short term. Also, if you invest for the long term, you will have more time to recover from short term losses.
Be careful when using fixed deposits for short-term investments
If you’re saving for a large upcoming purchase, like buying a car or putting down a down payment on a house, you may want to consider term deposits. Since these expenses are predictable, placing your short-term savings in a fixed deposit allows you to earn interest so that your money does not lose value due to inflation before you make your purchase.
But make sure you can liquidate your fixed deposits in time to pay for those purchases. For example, if you are looking to buy a house in 12 months, you should use a fixed 12 month deposit to get the best rate on that money. It can be tricky to constantly align the maturity periods of your fixed deposits with when you want to make withdrawals.
Plus, you don’t have the flexibility and freedom to change your mind about your goals when using a fixed deposit. What if you change your mind and want to buy a house in six months instead of 12 months? Losing the returns you’ve accrued on your fixed deposit shouldn’t be a price to pay for being able to do what you want with your money.
An alternative to fixed deposits
Alternatively, you can use a cash management portfolio like StashAway Simple. This allows you to earn a rate comparable to a fixed deposit, but without locking in your funds. Whether you use your money for your short-term savings or your emergency fund, StashAway Simple fits into your financial plan as another low risk investment that you can withdraw at any time, without losing accrued interest.
This article was written by StashAway.
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