<i>Illustration: Rocco Fazzari<i>

Illustration: Rocco Fazzari

Only two years ago, financial institutions were bending over backwards to attract depositors' cash with interest rates on term deposits of more than 6 per cent. Now interest rates are lower, more legwork by savers is needed to find the best rates.

But for depositors wanting absolute security for their money, good deals are still on offer.

At the time of writing, the best online saver rate is ME Bank's Online Savings Account with 5.1 per cent. Researcher Canstar says Citibank's Online Saver and ING Direct's Savings Maximiser share second spot with 5 per cent. Of the big banks, the best online saver rate is 4.9 per cent from the Commonwealth Bank's NetSaver. Be aware that these interest rates include the ''bonus'' rate that is usually paid for a certain time after the account is opened, after which the interest falls to the lower ''base'' rate. The bonus rate can apply for as little as three months.

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A financial analyst with researcher Canstar, Adam Beu, says providers know that many savers are likely to stick with the online saver account beyond the bonus rate period. While one of the biggest differences in online savers is the length of the bonus interest period, some have additional conditions that have to be met to earn bonus rates. For example, they could include maintaining a minimum balance or that a minimum amount must be deposited regularly into the account.

Savvy savers who are prepared to switch to a better-paying online saver before the end of the bonus period should be able to keep earning 5 per cent and have daily access to the money. And, as with term deposits, online savers are covered by the government's deposit guarantee, under which the first $250,000 is protected.

TERM DEPOSITS

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For savers wanting a fixed rate of interest, term deposits are paying, on average, about 4.5 per cent across maturity periods; a little less for terms of less than 12 months.

That is not as good as two years ago, when the rate was 6 per cent, or even a year ago when the typical interest rate was about 5.4 per cent. The best-paying one-year term deposit listed on Canstar's database is Ubank with a rate of 4.7 per cent, followed by ING Direct with 4.6 per cent and the Qantas Staff Credit Union with an ''effective'' rate of 4.59 per cent.

The term deposits in the accompanying tables, except for 90-day periods, are ranked by ''effective'' interest rates rather than ''nominal'' ones.

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Depositors should pay attention to the effective rate because it takes into account the frequency of the interest payments. For example, with two term deposits with the same ''nominal'' or advertised interest rate, the term deposit with the highest frequency of interest payments will have the highest effective rate.

Consider two one-year term deposits with one paying the interest at maturity and the other paying it each month. The term deposit paying interest each month is worth more to savers and has a higher effective or actual interest rate. That is because the saver starts receiving interest income only one month into the investment and the saver can spend or reinvest the interest, whereas the saver in the other term deposit has to wait longer before receiving interest.

ROOM TO NEGOTIATE

For savers with large licks of cash, there is always room to negotiate a better term-deposit rate than the advertised one, Beu says. For amounts of at least $100,000 there should be a lot of room for negotiation, he says. ''The power is with the saver if they have the money, as the institutions would like to get hold of it,'' he says. Institutions have to source some of the funds they lend out for mortgages and other loans from overseas because they cannot raise enough from domestic depositors.

And even though the costs of overseas funds have come down since the height of the global financial crisis, the institutions are still competing for the local depositors.

Savers can get caught out at the end of the term if they are not careful. When the term is nearing its end, the provider will contact the saver. But most term deposits have conditions that say if the institution does not hear from the saver, the money in the term deposit will be rolled into another term deposit with the same time to maturity at prevailing interest rates. Savers need to be careful and make sure they notify their term-deposit provider that they want their money back or check what term-deposit rates are being offered, not only by their provider but by competitors.

STRATEGIES FOR SAVERS

Most economists are forecasting at least one more 0.25 per cent cut in interest rates this year, drawing to an end the Reserve Bank's rate-cutting cycle. The central bank has cut the cash rate by 1.75 points since November 2011 and, at 3 per cent, the cash rate is equal to its GFC emergency low.

The long-term average for the cash rate is 5.5 per cent. Interest rates will, eventually, move higher. Savers may be better off parking their money in an online saver to earn a higher interest rate or in a term deposit with a shorter maturity. The effective interest rate on online savers is higher than the advertised rate because usually interest is credited to the account each month.

The interest is compounded, and so the actual rate of return is higher than the nominal or advertised rate.

The managing director of term-deposit broker The Term Deposit Shop, Grant Goodier, says interest rates from three-month to 12-month term deposits are flat at about 4.25 per cent.

''That is telling us that the deposit-taking institutions are thinking that we are getting near the bottom of the cash [interest rate] cycle,'' he says. ''If you want to maximise your return you would not be locking in for more than 12 months.''

Locking in for no more than 12 months gives protection against more rate cuts without forgoing the chance of taking advantage of higher rates later on.

''If you want a little bit more of a return kicker you can go with the online savers and get about 5 per cent, but the risk is that if cash rates do go lower, so will the interest rates on online savers,'' Goodier says.

A founder of financial products comparison website Finder.com.au, Jeremy Cabral, says another good strategy is ''term-deposit laddering'', whereby the saver divides the money and puts it into term deposits, which could include an online saver, with different maturity dates. With laddering, the money in the shorter-dated term deposits will be available to invest in higher-interest-paying term deposits.

Higher returns come with more risk

With term-deposit rates not as high as they were, some savers chasing higher income will be tempted to seek higher-paying investments that are not covered by the government deposit guarantee. To do better than term deposits, investors are going to have to take some risk with their capital. For example, higher-yielding shares such as Commonwealth Bank shares are on a cash dividend yield of 5.4 per cent, or a ''grossed up'' yield (after the benefit of imputation credits) of 7.7 per cent. But income investors will want to diversify between investments to help mitigate the risks to their capital.

One way of diversifying is through managed investment that holds shares in several companies. Managed funds called ''income share funds'' have been launched by fund managers for investors looking for tax-effective income. The funds mostly invest in higher-yielding Australian shares. Over the past year, the grossed-up yield on the Australian sharemarket has been more than 6 per cent. In addition, Australian shares have been staging a rally since the middle of last year. But while investors may be attracted to the good yields on offer from income share funds, they have to accept that there will be considerable volatility in share prices.

There are good alternatives to unlisted managed funds called exchange-traded funds (ETFs). They are listed on the Australian sharemarket. Most ETFs are index trackers, meaning their returns mirror the market returns they are tracking. There are even ETFs that track just the Australian sharemarket's higher-yielding shares, and ETF units can pay distributions to investors. ETFs are traded like any shares, and management fees are lower than for managed funds; though, as listed investments, investors face brokerage fees each time a parcel of ETFs is bought or sold.