In 2004 there was $280bln in term deposits, today the figure is around $540bln, so its almost doubled.

Advisers also acknowledge the excess cash clients are currently holding. In a survey of advisors conducted by Investment Trends in October 2009 one of the questions asked was .

"Across your entire client base, what level of excess cash/savings do you estimate has built up that would normally be invested in growth assets, but hasn't been as a result of the volatility?"

On average that number came out at $3.7mln per adviser with the median response at $1.3mln which across the industry amounts to around $50bn in excess cash from the GFC.

Clients have certainly taken to term deposit rates and I put it down to three reasons.

1) The government guarantee.

2) The scarcity of capital and chase for retail deposits from the major banks offering attractive rates when compared to the cash rate.

3) A loss of faith in growth assets in the midst of the GFC which has made investors much more risk averse.

At the moment you can get 1 year Term Deposit rates at 6.5%, 3 year at 7.2%, and 5 years at 7.5%.

These TD rates however are in line with their historical average. In a historical context they are not that high.

If we look back over the last 21 years 1 year term deposit rates have averaged 6.3% roughly in line with today's 1 year rate.

We did have a period in the late 1980's and early 1990's where TDs where extremely high above 10%, but even excluding this period the current TD rate on offer is not materially different to the rates offered over the last 15 years.

Of course what matters is the real rate of return not the nominal rate of return.

So if we adjust for inflation you'll see that even after adjusting for inflation the current TD real rate is again roughly around historical averages and certainly not to such an extent that explains the big rise in enthusiasm for term deposits.

The big factor along with the government guarantee as has been the differential between the term deposit rate and cash rates.

There has been a close relationship between the cash rate and that of term deposits. If you trace back over the last 20 years you can see a very close pattern. As cash rates have come down so too has term rates and as cash rates increased so too have term deposits. You can also see that when the RBA was lowering cash rates aggressively during 2009 term deposit rates followed. Then the nexus was broken, over the past year where term deposit rates have risen far greater than the cash rate.

Another way of viewing this is by plotting the spread between 1yr TD and that of cash.

You can see from this chart that the dramatic and unique environment where TDs are now offering a 2.0% advantage over cash rates, something we have not seen in the past 20 years and a function of the grab for cash by the banks in a world of scarce capital.

The point is, the rise in TDs is not a result of the absolute returns as there is little evidence to support this historically. Instead what has lead the flows is a combination of unique circumstances being:

• The government guarantee (unique)
• The 200 basis points spread between TDs and cash (unprecedented)
• A dramatic rise in risk aversion. (fear)

These three factors has influenced investor behaviour and whilst you can understand the short term attractiveness of term deposits the long term strategy should not change and it will come down to investor confidence. Investors should be aware of the big bet they are taking, even in today's environment where TDs appear attractive.

Term Deposit Rate vs Dividend Yields

When you consider what a term deposit yields you compared to dividends in the equity market over the same period you see that the terms rates are constantly higher than the dividend yield except for a brief period in mid 2003 and for twelve months during the credit crisis. The point is that term deposit rates will generally always offer a higher rate of return than say dividend yields.

This spread has varied from a massive 10.2% in favour of TDs in 1989 to – 2.9% at the height of the GFC.

Today's spread between one year term deposit rates and dividend yields is 240 basis points which historically is not high. In fact the 31 year average has been 242 basis points.

The question then is, how has the historic 240 basis points average advantage that term deposit have offered compared with an equity investment.

$100,000 invested in a one year term deposit in April 1989 at 15.0% and rolled over every year would have earned you $140,290 over the whole period i.e. 1.4 times your invested capital.

An equivalent investment in the equity market would have earned you a cash income of $169,700 over the same period i.e.1.6 times your invested capital but on an after tax basis the dividend flow over the years would have been worth $252,000.

What about the capital position?

Your capital in the term deposit would still be worth $100,000 but the equity capital would now be worth $327,000 paying out an annual income of around $11,800 which is 11.8% on the original investment which compares favourably with the current term rate of 6.3%.

The point is, that the current 240 basis points that TDs offer above the dividend yield is the same TD spread advantage that has historically been the case and despite the volatility and recent crisis in the equity market, it implies the investor is paying a very high price for risk aversion.

Looked another way TDs have not been a good long term investment at preserving purchasing power and standard of living even at the today's TD rate. If we adjust the numbers for inflation, then the message is probably clearer.

An investment in a 1yr TD even at the early 1990 rates of around 15% would have provided the investor in real terms a cash flow of $108,000. The same investor in the equity market would have provided the investor with a real cash amount of $117,000.

Importantly the last payment the equity investor in real dollars would have received was $6,500 and compares with the first year income of $4,800. That is, the purchasing power of the investment from a cashflow perspective has been maintained. The latest TD payment in real dollar terms was $3,000 compared with $15,000 in the first year.

When you consider that the original $100,000 TD in today's dollar is worth $55,000 it compares poorly with the real capital value of $180,000 from the equity market.

The message is simple: a higher current rate will always be attractive but it does little to preserve ones standard of living and if investors are favouring TDs today on the basis of the spread above cash and risk aversion they need to understand the price they are paying for that comfort and is a 240 bp above the dividend yield sufficient.

What do you need to believe to leave your cash in TDs? In other words what do I need to believe of equity markets to switch from cash back into equities.

Before I consider that I am interested via a show of hands how many believe that on a per annum basis the market will deliver a negative return over the next five years?

How many believe that the return on a per annum basis will be something between 0-5% nominal?

How many believe that the return on a per annum basis will be greater than 5% nominal?

5 year term deposit rates are trading at 7.25%. What do you have to believe from equity markets to better than that?

If you take the current dividend yield of 3.6%, the current market consensus EPS growth rate of 8.5%, next year 12.8% the following year 10.9% and assume a conservative 3% growth for years 4 and 5 with a payout ratio of 65% (which has been the average payout ratio of the last five years) then you can determine for the next five years the dividend cash flow from the equity market.

Knowing that, how much do equity markets on a per annum basis need to grow to provide a better return than term deposits?

The answer is 2.8% per annum. Equities need only grow by 2.8% p.a. over 5 years to beat a 7.25% 5 year term deposit currently on offer. Of course you will need to consider the trade-off between the lack of liquidity but stable capital from a term deposit investment against a highly liquid but less capital stable equity investment.

We know have a basis to judge how risk averse we want to be with our investment but I would argue that 2.9% pa returns over the next five years from equity markets is not a big hurdle given where we are in the economic cycle and having just gone past the GFC.

As markets settle and the high level of risk aversion eases then I think you will see the current high level of cash in TD unwind because in the long term the maths is too compelling but it does require a dose of confidence.

The government guarantee will come off and investor confidence will return. The Banks however having secured the cash are not going to let it go that lightly in a capital constrained world and so the TD spread above cash will remain for some time continuing to entice investors but buyers need to be aware of the long term implications.

With uncertainty also comes opportunity. Investors who will back the courage of their own convictions are the ones most likely to benefit the most as we invest in a world of risk aversion as opposed to risk appetite. The time to be risk averse was when the rest of the world was long risk and the time to be long risk is when the rest of the world is risk averse. Rarely in investment markets is the herd mentality correct and the herd at the moment is risk aversion and high cash.

I thank you for your time and happy investing.

Emilio Gonzalez