Term deposits can offer higher income returns than other types of savings accounts. By tying up your cash for a specific period, for example two years, you may be able to obtain a higher interest rate than a savings account which does not have withdrawal restrictions.
However, even the interest rates on term deposits are likely to be significantly less than the income returns of dividend shares. As such, with many stocks now trading on lower valuations following the recent decline in global equity markets, today could be the right time to focus your capital on undervalued income shares.
Buying dividend shares is a riskier move compared to using term deposits. After all, share prices can move lower, and dividends may be cut when a company delivers a disappointing financial performance.
However, the track record of dividend shares shows that they have historically offered a much higher overall return than term deposits. Therefore, buying a diverse range of dividend shares could be a sound means of gaining exposure to higher returns, while also limiting your dependence on a small number of companies. This may lead to a more resilient income stream, as well as a high and growing level of dividends over the long run.
With the stock market having come under pressure in recent months due to the outbreak of coronavirus and its potential impact on the world economy, a number of dividend shares appear to be trading on low valuations. This could mean that they offer even higher income returns relative to term deposits, thereby making them increasingly attractive to long-term investors.
In addition, there may be greater scope for capital growth than there was even a few months ago. Although your main focus may be on generating an income from your portfolio, obtaining capital growth could be an added bonus. Since the stock market has always recovered from its variety of downturns during its history, a rebound from its current challenges seems to be highly likely. As such, buying following its recent fall could be a shrewd move.
Interest rate path
Looking ahead, an uncertain outlook for the world economy could make interest rate rises less likely. Policymakers may decide to continue to support the economy’s growth prospects through having a relatively low interest rate. This may mean that the interest rates that are available on term deposits become even less favourable compared to the yields on dividend shares.
Therefore, now could be the right time to buy a wide range of income shares and hold them for the long run. The higher potential reward that they offer compared to term deposits, and the scope to limit risk through diversification, may mean that they are an increasingly desirable choice for anyone who is seeking to maximise the income return on their capital over the coming years.
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