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High interest savings accounts not what they seem

High-interest online deposit accounts may not be the golden goose many Australians have been thinking.

Financial researchers at Canstar suggest the average interest rate paid on line savings accounts has slipped to just 2.53%, less than the Reserve Bank’s cash rate of 3%. When tax and the Medicare Levy are taken into account, the rate of return drops to less than 2%.

With a raft of promotional offers that expire after a period, and other bonus offers, financial services providers have heavily promoted their products as offering high interest rates, but the devil is in the detail and the fine print. While consumers can earn bonus interest by not withdrawing funds, or making regular contributions, most savers will be earning low base rates of less than inflation, once the “honeymoon” period has lapsed.

For those investors with a stake in the $588 billion estimated to be on deposit with banks, the news is likely to get worse. Competition for deposits is fading, pushing down interest rates, as banks can now source cheaper funding from wholesale markets.

Manager of research at Canstar Chris Groth has told Fairfax Media that banks have lowered base rates, but kept promotional rates higher, knowing that very few people would move their money to chase specials.

All of which means investors would likely be much better off in shares that pay fully franked dividends. Several large companies on the ASX including banks Westpac Banking Corporation (ASX: WBC) and National Australia Bank (ASX: NBA), stock exchange operator ASX Limited (ASX: ASX), and telecommunications giant Telstra Corporation (ASX: TLS) pay fully franked dividends yielding more than 5%, and that doesn’t include franking credits. Grossed up, investors could expect to receive more than 7%, putting the returns on so-called high interest deposit accounts to shame.

Foolish takeaway

As with the unwillingness of borrowers to switch mortgage lenders to get a cheaper rate, banks have taken the advantage of retail investors’ apathy. Unless investors decide to walk away once their deposit rates fall, most will be earning below average returns, and in ‘real’ terms (including inflation) will actually be going backwards. Yet another reason to give deposits the flick.

The Australian Financial Review says “good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit.” Get “3 Stocks for the Great Dividend Boom” in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!

More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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