The 80’s were memorable for a number of reasons. Fluorescent clothing, Olivia Newton John, the America’s Cup win and the average interest rate on one-year term deposits of 13%.
There was no Government guarantee of deposits and the Commonwealth Bank of Australia had not even listed (that happened in 1991 at $5.40 per share). Since then rates have been volatile but on a steady downward trend for the last 35 years. Likewise, inflation has come down significantly from highs of over 12% in 1982.
What conclusions can we draw from this chart? Obviously, term deposit rates are at a record low. But this is only part of the story. To determine the real value of a term deposit we need to look at the real return. That is, the term deposit rate less the rate of inflation. If that gap is small our real return is small. If inflation is greater than the term deposit rate as it was in 1998, 2001 and 2008 investors are actually losing money by putting it in the bank.
Term deposits: not a good deal
The chart below shows the real rate rates of return on term deposits since December 1981.
It is clear that the real return on bank deposits has been decreasing over time. Some of this can be explained by the lower risk – attributable to the Government bank guarantee. But really, this shows that term deposits have shifted from a sensible investment product to a convenience product. Real returns of less than 1% should not excite anyone.
Better fixed income returns
Fortunately, there has never been more choice for Australian’s looking for a better fixed income return. With a moderate increase in risk, investors can earn significantly greater returns. The banks have been doing this for years, and it is high time that retail investors get a chance to invest in similar assets. The chart below shows the rates that banks have been charging on various types of loans since 1981.
A few things stand out. Mortgages and small business loan rates have been coming down since April 1995 and we all know why. Disruptors such as Aussie Home Loans and RAMS forced the banks to start pricing fairly.
However, personal loans are basically at the same place as they were 20 years ago. This is during a period when default rates have been low and the economy has been strong.
Real returns fail to keep pace with inflation
The story is more interesting when we look at real returns to the banks on personal loans.
Real rates have actually gone up over the last 20 years. This is in the context of a generally stronger economic conditions and low default rates. So let’s draw all this together. Term deposits are at historically low returns. More importantly, real returns on term deposits have come down consistently for the last 20 years, in some cases hardly keeping pace with inflation. In contrast, the real return on personal loans has been increasing, giving the banks exceptional returns for the risk.
How to invest in consumer loans
Until recently, access to the consumer loan asset class was limited to banks and credit unions. However, thanks to the emergence of consumer lending, Australian retail investors now have the opportunity to access this asset class.
Most consumer lenders have chosen to focus on borrowers with high-quality credit profiles and personal loans up to $45,000. Small loans like this allow greater diversification and lenders benefit from substantial data available to the online lending platforms which allow them to make informed credit decisions. SMSFs are finding that the yield and risk profile of consumer credit is a welcome addition to a well-diversified investment portfolio.
Plenti^ offers investors the opportunity to invest in personal loans with the added protection of Plenti’s Provision Fund. The Provision Fund is not a guarantee but is a buffer against losses. To date it has ensured that every Plenti investor has received every cent of principal and interest due.
Plenti has over 50,000 customers, 15,000 of them lenders and has lent over $500m to Australian consumers since 2014.
^Plenti was known as RateSetter prior to August 2020.
Note: all data in charts sourced from the RBA.
This information does not constitute financial advice and you should consider whether it is appropriate to your circumstances before you act in reliance on it. Any opinions, forecasts or recommendations reflect the judgement and assumptions of Plenti as at the date of publication and may later change without notice.