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Other Financial Assets: Cash Deposits and Property

Other Financial Assets: Cash Deposits and Property

I. Cash Deposits

Definition

  • Accounts held with banks or other savings institutions.
  • Held by a diverse range of depositors (retail investors, companies, governments, etc.).

Characteristics

  • Return: Primarily interest income; no potential for capital growth.
  • Capital Repayment: Initial deposit amount (capital) is repaid in full at the end of the investment term.

Types of Accounts

  • Instant Access:
    • Money can be withdrawn at any time.
    • Typically earn the lowest interest rates.
  • Fixed-Term:
    • Money is tied up for a fixed period (e.g., 1, 2, 3 years).
    • Higher interest rates than instant access accounts.
  • Notice Accounts:
    • Require notice before withdrawals can be made (e.g., 30, 60, 90 days).
    • Offer higher interest rates than instant access, but lower than fixed-term accounts.
  • Current (Checking) Accounts:
    • Generally pay the lowest rates or no interest at all.

Factors Affecting Interest Rates

  • Deposit Amount: Larger deposits often earn better rates.
  • Term Length: Longer periods result in higher rates.
  • Competition: Intense competition between deposit-taking institutions can affect rates.
  • Monetary Policy: Base rate changes in a country have a direct impact on rates.
    • Recent low base rates have led to historic lows and, in some cases, negative rates.

Taxation of Interest Income

  • Income Tax: Interest is generally subject to income tax.
  • Tax at Source: Many countries deduct tax from interest before it is paid to the depositor.
  • Gross Interest: The interest rate quoted before the deduction of tax.
  • Net Interest: The interest rate after tax deduction.

Islamic Savings Accounts

  • Shariah Compliance: Adhere to Islamic principles that prohibit interest payments (riba) and encourage risk sharing.
  • Profit Sharing: Instead of interest, banks pay a share of the profits generated from investments (avoiding anything that Shariah law dictates is harmful).
  • Expected Profit Rate: Banks advertise an expected profit rate (percentage return), which is not guaranteed.
  • Withdrawal: If profit rates fall, depositors are usually offered a choice to withdraw with accrued profits or continue at a new profit rate.
  • Accessibility: Open to all, not just Muslims, as the ethical guidelines may appeal to many.

Advantages of Cash Deposits

  • Liquidity: Easy and quick access to cash for spending needs.
  • Savings Vehicle: Useful for saving money and earning interest returns.
  • Safety: Cash investments are not subject to market volatility as are other types of assets.

Disadvantages of Cash Deposits

  • Creditworthiness Risk: Banks and savings institutions can default, and must be assessed.
  • Inflation Risk: Inflation can erode the real return on cash deposits, and often, the after-tax return can be negative.
  • Interest Rate Variability: Returns vary and are affected by central bank rate decisions.
  • Low Returns: Low global interest rates can result in negative or flat returns, especially after fees and charges.
  • Bank Failure: Risk that a bank or savings institution could collapse (although government compensation schemes protect deposits up to a limit).

Considerations for Overseas Deposits

  • Currency Conversion: Costs and exchange rate risks if the deposit is not in the investor's home currency.
  • Creditworthiness: Assess the banking system and the chosen institution.
  • Depositor Protection: Verify the existence of a depositors' protection scheme and whether non-residents are protected.
  • Tax Treatment: Understand the tax treatment of interest applied to the deposit.
  • Exchange Controls: Check whether any controls restrict access to the money and its repatriation.

II. Property

Unique Characteristics

  • Uniqueness: Each property is unique in location, structure, and design.
  • Subjective Valuation: Valuation is subjective; property is not traded in a centralized market and lacks reliable price data.
  • Legal and Transaction Costs: Subject to complex legal requirements and high transaction costs.
  • Illiquidity: Relatively illiquid due to not being instantly tradeable.
    • Investors must typically sell the entire property, not just part of it.
  • Diversification Challenges: Limited diversification due to discrete and sizable units.
  • Supply: Supply of land is finite and subject to restrictions. Price is predominantly determined by changes in demand.

In Summary

Cash deposits are a low-risk, highly liquid asset offering a basic interest return, but are vulnerable to inflation risk. Property is a unique asset class, being illiquid, having subjective valuation, and high transaction costs. Both asset classes are important components of a diversified investment portfolio, but have different risk and return profiles.

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