Written by R. A. Stewart
Two excellent wealth building vehicles are fixed term deposits and dividends paying shares. Both aim to put your capital at work but they operate differently as far as risk, return, and tax treatment goes.
Fixed-term interest
Your money is invested for a predetermined period of time, this could be for months or years for a guaranteed interest rate.
Investors in fixed-interest deposits know the return they are receiving on their investment.
Dividends
Dividends are made by the companies to their shareholders; they represent dividends of the company’s pot-tax profit.
Investors in companies on the share market do not know the return they are receiving. It is the directors who decide how much to distribute to shareholders.
Investors in the share market aim to receive a regular income through dividends and capital growth of their shares. (share price appreciation)
Key Differences
Fixed-term interest
- Capital Preservation and Steady income.
- Low capital risk
- Fixed and guaranteed income
- May lag inflation depending on the interest rate.
- Money not available until maturity
Dividends
- Income growth and capital appreciation
- Moderate to high capital risk due to market volatility.
- Variable income depending on how well the company is doing.
- Shares have historically outpaced inflation.
- High liquidity. Shares can be sold when markets are open.
Which is more risky?
The main risk with fixed term interest is inflation risk where the purchasing power of your money decreases with rising costs. The other factor to consider is that the market rate of interest may increase during the time you are locked into a lower interest rate.
The main advantage with shares is that it can be quickly turned into cash when needed. The flip side to this is that the markets may be down just when you need that money but thanks to managed funds and micro investing platforms it is possible to invest in such a way as to minimize the risk of being on the losing side of a downturn in the markets.
It is a matter of investing according to your timeline.
If you need the money within twelve months or the money needs to be on call then a personal bank account paying next to no interest may be your best option. However, fixed term interest may be your best option, if you have $5,000 to invest and need that money for say, a car in six months to a year. Your other option if you are in that position is to invest in a conservative fund. Your money will be invested in shares but in less risky companies.
What about the medium to long-term?
Shares have traditionally outperformed returns on fixed-term interest in the long run.
If your timeline is long-term then past history indicates that you are better off investing in shares.
It is important to stay calm when the markets are down and your retirement fund balance has dropped. Just continue to live your life, working and making contributions to your retirement fund and let the final balance take care of itself.
About this article
This article is not financial advice and may not be applicable to your personal circumstances therefore discretion is advised. You may use this article as content for your blog or ebook.
Read my other articles on www.robertastewart.com
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