Why are interest rates lower on longer term deposits?

It stands to reason that the interest rate on your term deposit should rise as the time to maturity lengthens. After all, the bank has the certainty of using your money for longer and you take the risk of missing out if interest rates rise.

Yet some three-year term deposits are currently paying a lower or similar rate of interest to six-month terms. We have the global economy to thank for that.

Many developed countries are struggling and their governments are lowering the cost of borrowing in a push to boost economic activity.

Nobody believes interest rates will rise any time soon and with plenty of cash around there is no incentive for rates to rise.

In this case, why would you hold a longer term deposit?

In fact, there is still a place in an investment portfolio for term deposits with maturities of 12 months and over.

In buying a longer term deposit, you are locking in your return in an environment where many expect interest rates to fall further.

You may gain nothing by buying successive shorter term deposits in a falling market when you could have earned more from a two-year term.

There is also the role that term deposits play as a safe haven investment.

An investor may choose to take on more risk in another sector of their portfolio knowing their term deposit offsets that exposure with a guaranteed return and the capital protected.

In this scenario there can be even more value in locking in a return for a longer period, when the outlook on other investments is far from clear.

Interest rates may not rise for years and could fall further.

Longer term deposits offer security at a time of uncertainty and the knowledge that on maturity, both principal and return can be withdrawn or reinvested.

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