12 - 24 months fixed deposit could be a better option than investing into a 1 – 2 year Gilts!

Although it is not fair to compare an investment against a fixed deposit, we believe that there is always a debate between investing and depositing. The question is, if we have GBP50,000, what shall we do?

Char 1: UK Government Bond Yield against the GBP Fixed Deposit Rate

Since December 2021, the Bank of England (BoE) raised the benchmark interest rate from 0.1% to 5.25% (as of 3 August 2023). After 14 rounds or 515 basis points of rate hike, the market start to anticipate that it might close to the end of this rate hike cycle. Based on the latest market consensus, they are still expecting the BoE to have another 25 basis points of rate hike on 21 September 2023.

Although it is still broadly expect at least one more rate hike in 2023, the bond market has been pricing in a rate cut in the next one to two years. Based on the information from Bondsupermart.com, Chart 1 shows the latest yield of the UK Treasury Bill and the UK Gilts in blue. It is obvious to see an inverted UK yield curve, meaning the longer-term yield is lower than the shorter-term yield. In layman terms, the return of investing into a longer-term bond is lower than the return of investing into a shorter-term bond. During the normal economic environment, the yield curve should be upward slopping and investors who are keen to take a higher duration risk should compensate by a high yield (or return).

On the other hand, the orange line in Chart 1 refers to the fixed deposit rate offered by the iFAST Global Bank. Although it is not fair to compare an investment against a fixed deposit, we believe that there is always a debate between investing and depositing.

Let’s put aside the interest rate expectation, as a normal investor, if we have GBP50,000, should we consider to invest into the UK Government Bonds (T-Bills or Gilts) or to go for a fixed deposit. A simple way to look at this issue is to compare their returns. If an investor has an investment horizon of less than 1 year, refer to Chart 1, it is obvious that the UK Treasury Bill has a much higher yield than the fixed deposit with the bank. However, if an investor has an investment horizon of 1 to 2 years, fixed deposit rate is much higher than the yield that the UK Gilts can provide. In particular, as compare to a 2 year fixed deposit rate at 5.1%, it is almost 60 bps (or 0.6%) higher than a bond with a similar maturity. As a result, based on the absolute return point of view, if an investor who is willing to lock up their investor for one to two years, probably a fixed deposit is a much better option as compare to investing into Gilts.

It is always true that there are Pros and Cons for investing or depositing. For example, if you invested into a bond, you are subject to market volatility while you can always cash out as long as there is a buyer in the secondary market. On the other hand, if you entered into a 2 year fixed deposit contract, your cash might be locked up for 2 years and any early redemption might subject to a penalty. However, there is no market risk involved and it is also covered by the Financial Services Compensation Scheme for up to GBP85,000.

Although we are still having a view that the interest rate will stay high for longer, if you have less than GBP85,000 of spare cash and is considering for a conservative investment for around 1 – 2 years, a fixed deposit would still be a better option at the current market situation. While investment involved risks and when it is not compensated by a higher return, it is always a smart choice to take a step back and see if there is any safer alternative with a better return like a fixed deposit.