Are You Using Fixed Deposits for the Right Reasons?

08 June 2020

Many Malaysians like to keep their cash reserves in fixed deposits. In fact, Bank Negara Malaysia statistics show that Malaysians placed about RM500 billion in fixed deposits up until 2019. That’s a lot of cash in fixed deposits! To put that number in perspective, fixed deposits held by the government, financial institutions and businesses combined only come up to about RM450 billion.

While fixed deposits can play a role in a financial plan, it’s important not to put too much cash into your fixed deposits, or, especially, rely solely on fixed deposits for all aspects of your financial plan. Though you can keep your short-term savings in fixed deposits, you shouldn’t be using fixed deposits for your emergency fund and your long-term investments.

Don’t use fixed deposits for your emergency fund

Fixed deposits aren’t the right place to keep your emergency fund because, with a fixed deposit, your money is locked up. That’s not very useful in an emergency. With an emergency fund, you should prioritise liquidity over earning a high rate because you need to access the money at a moment’s notice. How can you pay for an unexpected medical bill or a car repair if your funds are locked up for 6 to 12 months?

Rather than keeping your emergency fund locked up in fixed deposits, you should go for an option that allows you to access your money quickly when life throws you a curveball. That could be a savings account, or a cash management portfolio, such as StashAway Simple™.

Don’t use fixed deposits for your long-term investments

You should not be using fixed deposits for long-term investments. Fixed deposits may seem safe because they guarantee you a rate, but in reality, keeping your cash in a fixed deposit account for 3 to 5 years (or longer) guarantees that your money compounds at a much lower rate than if you were to invest in a diversified investment portfolio in that same period of time.

The graph below shows how much more wealth you’d have over time if you invested your cash instead of putting your cash in a fixed deposit.

The value of your cash in a 2% fixed deposit account versus invested at 6% p.a in 20 years

Are You Using Fixed Deposits for the Right Reasons?

Assumptions: Returns compound annually

If you kept RM50,000 in a fixed deposit account that returned 2% every year, you would have RM74,297 in 20 years. On the other hand, if you invested that same amount in a balanced investment portfolio that returned 6% every year, your cash would have grown to RM160,356 in 20 years.

In other words, you would have earned RM86,059 more if you had invested your cash in an investment portfolio instead of keeping it in a fixed deposit for 20 years. Over the long term, investing your money magnifies the power of compounding, and makes your money work much harder for you.

Here’s another way to look at it: You’d have to put up a much higher deposit in your fixed deposit today to earn as much as you would have if you invested in the markets. To get RM160,000 in 20 years in a fixed deposit, you’d have to put up RM107,000 today whereas you’d only need to invest RM50,000 in the markets to get to that same amount in 20 years.

Even if you consider yourself risk-averse, you shouldn’t completely stay out of the markets. Keep in mind that investing isn’t inherently high-risk, you can choose to invest in lower-risk portfolios that limit your downside in the short term. Keep in mind that when you’re investing for the long term, your investments will have more time to recoup any short-term losses so you can afford to take a little bit more risk. In fact, markets have historically gone up over the long term and staying invested for 10 to 20 years or more allows you to ride that upward trajectory.

If you’re risk-averse, you can also take additional steps such as dollar-cost averaging to manage your risk exposure when investing in the markets, instead of relying on fixed deposits for your retirement savings.

Be cautious about using fixed deposits for your short-term investments

If you’re saving up for a big expenditure coming up in the next few months or in the next year, such as buying a car or putting a downpayment on a house, fixed deposits can be one place to keep your funds. Since these expenditures are predictable, you can use fixed deposits to earn a rate on your short-term savings so that your money doesn’t lose value to inflation before you make your purchase.

But, you also have to make sure you can liquidate your fixed deposits in time to pay for those expenditures. For example, if you’re looking to buy a house in 12 months, then you need to use a 12-month fixed deposit to earn the best rate on that cash. Constantly aligning your withdrawals with when you want to use your cash is a hassle.

Plus, you don’t have the flexibility and freedom to make changes to your goals when you use a fixed deposit. What if you change your mind and want to buy a house in 6 months instead of in 12 months? Losing the returns you’ve accrued on your fixed deposit shouldn’t be the price you have to pay to get to do what you want with your money.

A better alternative to fixed deposits

Alternatively, StashAway Simple™ allows you to flexibly manage your cash and earn a projected rate that’s comparable to a fixed deposit, but without locking up your funds. Whether you’re using your cash for your short-term savings or your emergency fund, StashAway Simple™ fits in your financial plan as another ultra-low risk investment that you can withdraw from at any time without losing the interest accrued on that cash. Learn more about StashAway Simple™ here.

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