The Vanguard Australian Shares Index ETF (ASX: VAS) is a popular exchange-traded fund (ETF), with many investors appreciating the level of passive income that it produces.
Term deposits can be equally appealing because they can deliver a solid, guaranteed interest rate while also protecting people's capital.
Both investment options come with positives and negatives, so let's consider some of those.
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Passive income yield
Every month, Vanguard updates investors on the VAS ETF dividend yield. At the end of May 2024, the Vanguard Australian Shares Index ETF offered a yield of 3.7% which, together with its franking credits, takes the yield to just under 5%.
The VAS ETF's yield is comparable to the term deposit rate offered by ASX financial shares like AMP Ltd (ASX: AMP) and Judo Capital Holdings Ltd (ASX: JDO).
While each financial institution offers a different interest rate, the yield for a term deposit is fixed and guaranteed. In contrast, the Vanguard fund payout has the potential to grow over the longer term, but it can also be reduced in the shorter term.
If its holdings grow their profits and dividends, the VAS ETF distribution could be materially larger in five years. The term deposit yield will be entirely dependent on the RBA interest rate at the time, which has been hard to predict over the last few years.
What about capital?
Term deposits are designed to protect investor capital, so investors don't suffer capital loss during the course of the term deposit.
The VAS ETF invests in a portfolio of ASX shares, including BHP Group Ltd (ASX: BHP), Commonwealth Bank of Australia (ASX: CBA), Telstra Group Ltd (ASX: TLS), Coles Group Ltd (ASX: COL) and Macquarie Group Ltd (ASX: MQG).
Owning shares has the potential to deliver capital growth over the long term if those businesses can collectively perform. However, as everyone knows, volatility can quickly strike and cause a decline.
If you're an investor thinking about a short-term investment, a term deposit may be a better choice because it removes the risk of capital loss while still offering decent cash returns.
However, for the longer term, we should keep in mind that ASX shares can provide inflation protection by growing their profits, dividends and share prices. The term deposit return is fixed with no growth potential unless someone reinvests their interest into the term deposit.
Investors can spend their VAS ETF distributions and still see larger distributions in the future because of underlying business growth.
Of course, there are other investments that people can consider to diversify a portfolio further, such as the ASX dividend share Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) and an ETF like Vanguard MSCI Index International Shares ETF (ASX: VGS).
