I'm not attracted to term deposits because of a couple of key reasons. Hence, in my mind, ASX income shares look like the right place to invest.
Term deposits certainly have their place in our financial system – they can provide guaranteed returns, meaning you know what you're going to get. At the moment, the best term deposits offer rates of close to 5%, which is pretty good.
Some people may want to stick to the security of term deposits, and that's okay.
But for me, I don't mind the volatility that comes with ASX income shares, or any shares. There are always buyers and sellers who are willing to transact at different prices, depending on what's happening around the world. With that understanding, there are two main factors that make me want to choose passive income stocks over term deposits.
Growth from ASX income shares
Term deposits are great at limiting any possible downsides – there is no capital risk, and we get the capital return back at the end of the term. Plus, it's virtually certain we'll be paid the income we expect.
However, term deposits do not offer the potential for capital growth, and the advertised income is the best that investors can expect.
Owning shares comes with risk, but that also means investors open themselves up to growth and gains.
ASX income shares can grow their profit, whether by opening a new store, expanding into a new country, or selling more subscriptions. Profit growth can unlock share price growth and deliver dividend growth. ASX income shares can grow our portfolio wealth and protect against inflation while still delivering a good yield.
For example, a $1,000 term deposit could pay $50 (a 5% interest rate) in year one.
In a decent year for the share market, $1,000 invested in an ASX income share could pay $50 of passive income (a 5% dividend yield) and grow in value by 5% to $1,050. The business could then grow its dividend by 5% and pay $52.50 in the next year. The term deposit could be stuck paying $50 in year two, at best.
I said "at best" because we could see the income from term deposits fall in the near future, which would be a negative.
Term deposit rates to fall?
The interest rate we can get from term deposits is heavily influenced by the official cash rate from the Reserve Bank of Australia (RBA). Term deposits offer a much better rate now than four years ago because the RBA cash rate has jumped to 4.35%.
However, there are widespread expectations that interest rates are about to reduce in Australia because inflation has largely come under control in the country.
If rates are cut this year, it would make term deposits less attractive to me.
I think it'd be better to look at ASX income shares now before the rate cuts because there could be an investor shift to the ASX share market in the next year or two. Therefore, it's better to buy the shares at a better valuation today with a better dividend yield.
Right now, I'm thinking of appealing options like Brickworks Ltd (ASX: BKW), Centuria Industrial REIT (ASX: CIP), and Washington H. Soul Pattinson and Co. Ltd (ASX: SOL).
