Sunday, July 22, 2007

Fixed Income Products - Bank Deposit

What is your risk appetite towards investment? Are you so afraid to invest or are you willing to take some risk to improve your return on investment? Whether you are risk averse or a risk taker, there are products available in the market to suit your individual risk profile.

Today, I shall cover the safest investment options that you can go into to start growing your money and that is none other than bank deposits. Bank deposits are excellent investment options for emergency funds, capital preservation, and short term financial goals. These are practically risk free investments, that is you won't lose any money. However there is a trade off for that lack of risk and that is you don't get much return.

What is meant by "practically" risk free? It is risk free in the sense that you do not lose it in monetary term, but in term of its purchasing power, you will find that it declines over time. Why is that so? It is because of inflation. Inflation is associated with rising prices of goods and services. It is a condition in which too much money is chasing after too few goods. Hence if the interest you earn from the deposit barely covers the prevailing inflation rate, you would actually be losing buying power. So bear in mind that there is still a risk if you just leave your money idle in the bank.

Examples of bank deposits are saving deposit and time deposit.

Saving deposit is more liquid but has relatively lower interest rate than time deposit. It is liquid because you can draw it anytime you like. It is an excellent place to put your emergency fund.

Time deposit or certificate of deposit is not liquid compared to saving deposit because you are expected to let the bank locks up your saving for a period of time. Typically, you invest a fixed amount of money for a predetermined amount of time called the term, and you are guaranteed your principal plus a fixed amount of interest, which you receive either upfront, periodically, or at the end of the term. When the term expires, you can cash out the principal and interest, or roll over the deposit for another term. You can opt to withdraw the interest as they are received.

Time deposit or certificate of deposit can be purchased for terms ranging from three months to five years or more. Although interest rate is higher the longer you allow the bank to use your money, it is not a good idea to buy with term of more than five years. The interest rate situation could change dramatically during that time and you could get stuck with a long term, low interest rate deposit. As there is a defined date of maturity, cashing it in before that time will incur penalties.

In case you are not aware, saving and time/certificate of deposit are covered under the deposit insurance scheme in some countries.

For the risk averse, this is a good place to grow your money. For the risk taker, it has a place in your investment portfolio too as it helps to spread your risk. Very important though, you must make sure that the deposit interest rate is higher than the inflation rate. Also, bank competes for deposits by offering better than average rates. It is advisable that you shop around to find banks that offer the highest yield possible on your deposit.

Remember, there is still risk if you just keep your money idle in the bank. Give your money the opportunity to grow for you.

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