The Vanguard Australian Shares Index ETF (ASX: VAS) is a popular exchange-traded fund (ETF) investment option for many Aussies, but it's not the only choice for potentially good returns. Term deposits can also be good sources of investment returns.
In this uncertain world, it's understandable why some people may want the safety of a term deposit. It can provide risk-free interest to savers.
With interest rates so high, investors can get a pleasing interest return from a term deposit, but the VAS ETF is also known for its income returns. Let's look at the three main ways I'd want to compare these two investment options, including the passive income potential.
Passive income
Numerous financial institutions offer term deposits, including Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB), and ANZ Group Holdings Ltd (ASX: ANZ).
The business lender Judo Capital Holdings Ltd (ASX: JDO) also offers term deposits to Aussies, with a current personal deposit rate of 5% for a one-year time period. Considering where rates were three years ago, I'd say that's a pretty good prospective return.
However, the VAS ETF also has a high dividend yield, which can provide real returns. According to Vanguard, the VAS ETF has a dividend yield of 3.5%, and it also attaches franking credits, which is a refundable tax offset
At the current levels, the term deposit from Judo offers a higher income level, though any interest rate cuts would likely reduce the future income potential from subsequent term deposits.
Capital return
One of the main disadvantages of a term deposit is that it doesn't offer any capital growth. How much money we put in is how much we get back at the end of the term unless we re-invest the interest generated.
Shares can go up in value if investors are willing to pay more for those shares. It helps if the business is able to grow its profit, in which case the market is likely to push up the share price. Over time, businesses can invest some of the profit they generate into growth activities such as marketing, opening a new location or creating a new product.
According to Vanguard, the VAS ETF has returned an average of 9.2% per year since its inception in May 2009. That includes capital growth of an average of 4.66% per year. While that's not huge growth, it still means the ETF's investors have received a decent level of capital growth and passive income over that time.
Risks
However, while shares can go up, they can also go down.
Crashes can happen sometimes, such as the COVID crash or the GFC. We don't know when the next crash is going to occur; that's why they're so unpredictable. Hence, investors need to be aware the VAS ETF can go down in value. It will regularly see minor declines, and very occasionally, there could be a large sell-off.
Some people may not like living through a bear market and seeing their portfolio value go down. But I wouldn't suggest selling after a market crash because investors would be exiting at the worst time.
A term deposit may be a better choice for people who don't have the mindset of being able to hold through tough times.
However, I'm personally willing to put up with the volatility of shares, as market movements are the 'entry price' to invest in the ASX share market.
Ultimately, for my own portfolio, I'd choose the VAS ETF over a term deposit because of its ability to deliver capital growth over the long term.
