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23 February 2025

Choosing Between Bonds, Cash and Term Deposits

If you're saving for your first home or planning for retirement, securing a safe and reliable place for your savings is crucial.

With interest rates expected to trend lower in the near future, many Kiwi investors are facing the decision of where to invest their hard-earned savings for their short to medium-term goals.

This landscape has led an increasing number of Kiwis to explore possible alternatives to term deposits, in particular cash and bond funds.

In this blog, we will dive into the key differences between these three options, providing you with the insights you need to make an informed decision.

Understanding the three options

Term deposits

Term deposits offer an almost certain return over a fixed period.

Kiwis love them, they’re easy to understand and backed by your bank. In fact, as at the end of December 2024, there are over $259 billion in household savings in term deposits.

While certainty is there, they lack flexibility – as your money is locked away until maturity. Your money is non-transferable and may only be accessed in extreme circumstances, possibly at a high penalty.

Cash funds (also known as Money Market funds)

Popular overseas but less known in New Zealand, cash funds provide a flexible alternative to term deposits or your typical savings account.

These funds typically invest in a diversified range of high quality short-term money market instruments, fixed income and bank deposits, offering liquidity while still maintaining stable returns.

They're particularly suitable for those who want access to their money within a few days while earning competitive rates, similar to some term deposits.

However, they do have some (quite low) risks, mainly changing returns or underperformance.

You can learn more about cash funds here.

Bond funds

Widely used internationally, bond funds offer potentially higher returns than term deposits or cash funds with moderately higher risk depending on the flexibility of the professional manager’s strategy.

They are much less volatile over longer periods than growth assets such as property or shares.

They typically invest in a portfolio of government bonds and corporate bonds from stock exchange-listed companies. While they carry more risk than term deposits, they provide better liquidity and can benefit from professional management.

You can learn more about bond funds here.

Cash Funds vs Bond Funds vs Term Deposits: Compared

Please note features can vary depending on the platform, product and fund manager the below table is a broad generalisation.

Feature

Term Deposits

Cash Funds

Bond Funds

Current returns/ Yield to maturity (YTM)

1 year – 4.64% (1*)

4.67% YTM (2*)

4.22% YTM (3*)

Expected returns

Greater than on-call savings accounts

Likely to be better than 3 month term deposits (4*)

Generally higher than cash funds

Safety

Highest but undiversified

Very high and diversified

Good

Tax

Usually based on your RWT (39% Max), but PIE options are available

Portfolio Investment Entity (PIE) - Max 28%

Portfolio Investment Entity (PIE) - Max 28%

When can I get the money?

At maturity, can range from 1 month to 5 years.

Time to sell units: next business day. Withdraw to your bank: 1-2 business days

Time to sell units: next business day. Withdraw to your bank: 1-2 business days

Distributions (interest payments)

Usually at maturity, sometimes periodically

Income is accumulated, but can be chosen to be paid out quarterly

Income is accumulated, but can be chosen to be paid out quarterly

Credit risk

Excellent, extremely likely to repay

Low credit risk depending on portfolio, as individual investments could default or decline in value

Higher credit risk, individual investments could default or decline in value

Interest rate risk

None, until reinvestment

Limited interest rate risk

Higher depending on portfolio duration, related to NZ & Global risk

All yields as at 31 January 2025. Yield to Maturity (YTM) is annualised and after expected management fees. See respective links for the latest figures. 1* 1 Year Term Deposit used for simplicity for different maturities see source RBNZ, 2* Kernel Cash Plus Fund YTM, 3* Kernel NZ Bond Fund YTM. 4* This depends on the current bank funding environment, but the expectation is that the Cash Fund will provide returns similar to 6 month term deposits.


Why bonds have greater risk and expected reward

Governments and companies look to gain funding, and it’s from the bond market that they usually find it. However, to gain this funding, they must offer a higher interest rate than that of the short-term cash market.

Intuitively this makes sense, the lenders (i.e. the bond market including fund managers) are taking a greater risk on future interest rates, ability to repay and resellability than the short-term money markets – so to take this risk the lenders require a higher return.

For this reason, bond funds would normally be expected to make a greater return than a cash fund. Below is an example of the returns made by the Bloomberg NZ Bond Index vs the Bloomberg NZ Bank Bill Index.

Source: Bloomberg

From a long-term perspective, the performance of the NZ Bond index has outpaced the NZ Bank Bill index by approximately 0.80% p.a or around 30% higher return in just over 14 years, albeit with significantly greater volatility.

It is also quite notable that the out-performance was far greater until the bond market sell off in the post-Covid inflationary environment as central banks dramatically raised rates to combat inflation. You can learn more about that here.

Of course, an event of this nature can and probably will occur in the future at some unknown point.

Question:

If bonds tend to perform better, why is the Yield of the NZ Bond Fund currently lower than both the 1 year-term deposit and the Cash Plus fund?

Answer:

There are many factors that can explain this, which you can learn more here. However, at the time of writing, short term interest rates are higher relative to longer term bond yields as the Reserve Bank (RBNZ) is cutting rates and the bond market is anticipating further OCR reductions.

In a RBNZ rate cutting cycle, short-term deposit investors might get a better yield for the first several months, but when they go to reinvest their rates could be a lot lower. Over time we expect bond yields to be greater than short-term yields.

Question:

Will my return be the same as the yield on a fund?

Answer:

A fund such as a cash fund or bond fund might publish a yield – which represents the average market yield of the investments in the fund at that point in time.

However, depending on the future movement of the interest rate markets and the management of the fund, the actual return can be quite different (this is particularly true for a bond fund).

Kernel Funds: Cash Plus vs NZ Bond

A similar trend is reflected with the Kernel Cash Plus Fund and Kernel NZ Bond Fund. Below is a comparison of their performance against their respective benchmarks.

Both the NZ Bond fund and Cash Plus fund are actively managed– and therefore have a risk of underperforming relative to their benchmarks. The data shown starts at the inception of the NZ Bond Fund on 7 March 2024.

As shown, the NZ Bond Fund briefly underperformed the Cash Plus Fund in April 2024 yet by the end of January 2025, it has delivered higher returns.

However as illustrated by the wiggliness of the line, both funds have still been more stable than those of a share fund. For example, the S&P NZX 20 index is in light green.

Common use cases & time horizons

Term deposits

Are often suited for situations where you have a considerable lump sum of cash that you know you won’t need to access for the agreed term.

Cash funds

Often don’t have a minimum suggested time frame or minimum deposit amount. This makes them ideal for those who prefer quicker access to their money and/or accumulating their savings

e.g. saving up for a travel fund or even part of an emergency fund.

Bond funds

Are better suited for those looking for greater returns than term deposits or cash funds and don’t mind some volatility. This could be for those accumulating or have a lump sum they won’t use for 2+ years.

Or as part of a retirement strategy for those looking for consistent income or diversifying to reduce risk from shares.

In the US, where data is available for 50 years for a mixed fund of Government and Corporate bonds, there have been only five years with negative annual returns.

Using term deposits, cash and bonds

Below is a hypothetical scenario to consider.

Sarah, an avid investor and saver, has now reached the beginning of her retirement journey expecting to live at least 20 more years.

She has decided to invest $300,000 (a fraction of her total nest egg).

With relatively low expenses, Sarah aims to ensure this portion works effectively for her, balancing security, and flexibility, and maximizing returns.

Sarah's strategy reflects her comfort with taking on moderate risk for higher returns while maintaining ready access to funds when needed.

Investment Allocation:

Bond Funds ($150,000):

Sarah allocates the largest portion to bond funds to seek higher returns. She understands that bond funds carry risks such as interest rate sensitivity and credit risk but believes the potential for higher returns outweighs these risks over a few years.

Term Deposits ($90,000):

She invests a significant amount in term deposits for security and predictable income. This ensures that a portion of her money is safely invested, providing peace of mind.

Cash Fund ($50,000):

Is placed in a cash fund that she will regularly draw down from. Giving her easy access and flexibility as needed.

Day to day bank account ($10,000):

To cover her usual living expenses. The returns from the funds, along with her superannuation can let her cover most of her living expenses for a decent period.

If Sarah decides she needs more money she can then choose to sell holdings from her cash or the bond funds.

The verdict?

Unfortunately, there is no one size fits all approach. Ultimately this will depend on your own risk tolerance and situation.

While term deposits give you safety and transparency, they lack flexibility.

However, if you’re willing to seek a potentially higher return without significant risks, you may find that bond and cash funds are a better option for you.

Or why not consider the best of all worlds and invest across all three?


Disclosure: Past performance does not indicate future returns. The example provided is hypothetical and for illustrative purposes only. It is not intended to be taken as personalized financial advice.

The investment strategy and allocations described are based on general principles and may not be suitable for every individual. Readers who are unsure may wish to consult with a licensed financial advisor to determine the best investment strategy for their specific circumstances.

Tim Rodriguez

Tim Rodriguez

Marketing Specialist | LinkedIn

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Indices provided by: S&P Dow Jones Indices