Term deposits or ASX dividend shares as the RBA holds?

Watching the Reserve Bank of Australia move interest rates has become something close to a national sport. This week brought another match.

And despite inflation still running very hot, the board held the official cash rate at 4.35% rather than raise it again, its first pause after three hikes in a row this year.

That offers a moment of calm. It does not solve the deeper problem.

Headline CPI sits near 4.2% and the trimmed mean remains above the RBA’s 2–3% target band, where it has stubbornly stayed for a long time. The cost of almost everything has climbed for years, and those price tags are not coming back down.

So if you have capital set aside and you want it to generate income, a simple question will sit with you: term deposits or ASX dividend shares?

There is no single right answer. 

It depends entirely on you.

What certainty actually costs

A term deposit does one thing very well. It pays a fixed, known return and hands back your original capital at the end of the term.

With the cash rate steady, the big banks are offering around 5% on a one-year term, and the most competitive providers sit closer to 5.4% to 6%. Deposits up to $250,000 per institution (i.e. bank) are also covered by the Government’s Financial Claims Scheme, which is about as close to a guarantee as money gets.

For a retiree drawing income, or anyone who needs their capital intact within a year or two, that certainty is worth a great deal.

However, certainty has a price. Your money is locked away for the term, and breaking it early usually means forfeiting interest. The income is taxed at your full marginal rate. And with inflation near 4.2%, a 5% return leaves precious little once rising prices and tax take their cut.

You protect your capital. You do not grow it by much.

Why owners tend to win over the long run

Dividend paying shares flip the trade-off. There is no guaranteed return and no protected capital – share prices fall as well as rise. That risk is real, and it should not be waved away.

The reward is total return: the income, plus the growth in the value of the business behind it.

Take Washington H. Soul Pattinson and Co. Ltd (ASX: SOL). The diversified investment house has lifted its dividend every year for more than two decades, and over the past 25 years it has delivered a total shareholder return of roughly 12.9% per annum – comfortably ahead of any bank paid interest rates. Its recent payout, grossed up for franking credits, equates to a yield near 3.4%. 

Franking matters here. Those credits can lift the after-tax value of dividends well above the headline number, something a term deposit simply cannot offer.

Income-focused names tell a similar story. APA Group (ASX: APA) has grown its distribution every year since 2004, currently yielding around 5.8%. 

The catch is time. Shares reward patience and punish anyone who needs their money on a fixed date.

Foolish takeaway

This is not a contest with one winner. It is a question of fit.

If your time frame is short, your need for the capital is certain, or volatility keeps you up at night, term deposits earn their place. If you can stay invested for years and ride out the swings, owning quality dividend payers has historically delivered more.

Many investors land somewhere in between – cash for near-term needs, shares for the long climb.

The RBA may be on hold. Your money does not have to be. The right mix comes down to your time frame, your risk profile, and what you genuinely need it to do.

The post Term deposits or ASX dividend shares as the RBA holds? appeared first on The Motley Fool Australia.

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Motley Fool contributor Leigh Gant has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia has positions in and has recommended Apa Group and Washington H. Soul Pattinson and Company Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.