Smart Investor: Getting Started, October 2012

Smart Investor, October 2012

In Australia, we are blessed with some of the highest interest bank accounts in the developed world. Where Brits and Americans dream of getting 1% on their savings, Australians can get 5% for locking their cash away for as little as 90 days.

It’s not quite the advantage it appears, of course; if Australian savings rates are high, then mortgage rates are higher, as is broader inflation. But it is true to say that Australians have access to relatively high risk-free returns just by putting the money in the bank.

But how risk-free is risk-free? And is it simply a question of choosing the highest rate and putting your money away?

Before answering those questions, it’s useful to see what’s out there. Infochoice.com.au is a good example of a website that allows you to compare many different products at once. If, for example, you key in that you want to put $10,000 in the bank, in an online account, and are happy to lock it up for one year, you will see (at the time of writing) that you can get as much as 5.3% from ING Direct, 5.12% from RaboDirect, and 5% from Bankwest tddirect.

That’s fine if you’re happy locking your money away for a year. But what if you need access to your money? A search of at-call accounts shows that the highest base interest rate in the market is 5.01% from UBank’s USaver account, with a further 0.7% bonus if it is linked with a savings plan. Similar high rates include RAMS and Newcastle Permanent.

But the headline rate is only the start of the research you should do in deciding upon an account. Many high interest accounts have a great headline, but look closer and you will find it is just an introductory rate, which reverts to a much lower rate after three months or so. Clearly, it’s that later rate you need to be looking at if you hope to have this account for any length of time.

It’s also important to understand that many accounts have interest rates that are tiered. The more you put in, the higher a rate you qualify for on your savings. In some accounts, there is a bonus rate that kicks in either at a certain balance or in certain circumstances (like UBank’s savings plan). Will you be able to put in a sufficient amount to qualify for these top tier headline rates? If not, forget them – they’re not relevant to you.

Next, think about how you want your high interest account to interact with your regular transaction account. Perhaps you want an easy link between the two, with cash that can be transferred online at the press of a key. If your account is with one of the big providers, that will be straightforward, and it will be easy to see your savings and transaction balances together. Some people, though, find that far too much of a temptation and actually want to make it a bit more difficult to get at their cash.

Then there’s the question of security. Understanding internet security is difficult, and differentiating between the safety standards different banks apply is beyond the reach of most of us. But what you can form a view on is the creditworthiness of the bank itself. All banks have a credit rating – although the financial crisis showed some of those ratings to be flawed – and naturally the higher the rating, the more secure the institution and the less likely it is to fail.

There is a safety net, though it has been reduced in scope. During the financial crisis in 2008 the Australian government announced a guarantee of deposits up to $1 million. Then, in 2011, the deposit guarantee was reduced to $250,000, a change that came into effect earlier this year.  The guarantee doesn’t apply to accounts in branches of Australian banks overseas, but it does apply to deposits of foreign banks with an Australia-based banking licence.

Finally, the most eye-catching rates are on the longest-term lock-ups. RaboDirect, for example, offers 5.6% per year on a five year deposit. They can sound attractive. But consider whether you really can lose access to your money for that long – and is it really worth the extra 0.7% a year compared to the 4.9% you get from the same provider in a 90 day deposit? Be clear about what penalties apply for early redemption and just how likely you are to need access to that money along the way.