Personal-Finance

How to fix your deposit

2020-03-13 06:01

Over the past two years, interest paid by financial institutions relative to inflation was the highest since the end of the credit crisis in 2010.

Last year, unit trust money market funds paid investors on average 7.5%, while inflation was only 4.4%.

This means that, without taking any risk and having full flexibility on withdrawing funds, investors received a real return of more than 3% a year.

With the interest rate cut last month, these returns have decreased, however, if you are prepared to lock your money in for five years, there are still some good options available.

Despite the cut in the repo rate, African Bank has continued to offer a 10.75% a year return for a five-year fixed deposit. At current inflation rates, that would be a real return of more than 6% a year, which is the type of return expected from stock markets, not banks. Even the 24-month rate is offering 8.5%, which is well above inflation.

Banks incentivise deposits such as fixed and notice products, and there is fierce competition in the market, which is always a good thing for customers, who are able to take advantage of these opportunities.
Absa head of savings and investments Thami Cele

One of the reasons we are seeing higher deposit rates is that banks are prepared to offer higher rates to attract high quality, more “sticky” retail deposits, due to the requirements of the international, voluntary, regulatory banking framework Basel III. This would be even more important to a smaller bank such as African Bank, which is recapitalising after collapsing and being put under curatorship in 2014.

According to Absa head of savings and investments Thami Cele, retail deposits have become more attractive to banks due to the higher weighting Basel lll gives these types of deposits. Cele says that, while institutions move cash balances quickly as part of their cash management strategies, retail investors tend to leave their money alone for longer periods of time.

“Banks incentivise deposits such as fixed and notice products, and there is fierce competition in the market, which is always a good thing for customers, who are able to take advantage of these opportunities,” Cele says.

During 2018, the battle for deposits saw first Nedbank and then Absa offering 10% returns on five-year fixed deposits. These tend to be short-term marketing strategies, but astute investors can take advantage of these campaigns and lock in excellent long-term rates.

Money market rates are expected to decrease this year, while investors can lock their interest rates in with a fixed deposit

Money market unit trust funds have seen a decrease in their rates since the cut in the repo rate last month, and are currently offering 6.9%. Interest rates differ depending on institutions’ competitiveness. This is still relatively high for an investment that only requires 24 hours of notice for withdrawal.

However, Cele says that money market rates are expected to decrease this year, while investors can lock their interest rates in with a fixed deposit. Absa is currently paying a 7.75% effective rate a year for a five-year fixed deposit (this equates to 9.52% on maturity).

The question is what interest rates will do over the next few years – what if you have locked in for five years and rates increase?

Cele says predicting interest rates is challenging. While South Africa appears to be on a rate-cutting trajectory with inflation under control and a weak economy, the outbreak of the new coronavirus has put the rand under pressure. If the rand weakens significantly, it could trigger import inflation via higher oil and fuel prices, and result in an interest rate increase. The opposite is also plausible, as evident in the US announcing its biggest rates cut since 2008.

The bottom line is that trying to guess interest rates these days is virtually impossible in a volatile global environment. Most banks offer fixed deposits that allow for interest rate changes. However, this usually comes with a rate sacrifice. Absa’s Dynamic Fixed Prime Linked fixed deposit will offer an upside if rates increase, but currently pays about 40 basis points below the rate offered if you select a fixed interest rate. The differences in rates account for flexibility and opportunities of the upside in a Prime Linked Dynamic Fixed Deposit – so you pay for your flexibility.

As banks all have different cash requirements at different stages, it is worth shopping around for the best rate and also considering non-bank alternatives.

Tax considerations

If you lock your money into a five-year fixed deposit, it is important to note that, even if you only receive the interest on maturity, you will be liable for tax on interest each year as if you had received it.

For example, if you receive 10% interest on a R500 000 deposit, your account will receive R50 000 in interest in the first year. Even though you do not receive the money, you would be taxed on any interest above R23 800 if you are younger than 65 and after the first R34 500 if you are 65 or older.

The Fedgroup Secured Investment allows for partial withdrawal of the annual interest to meet your tax obligation.

If you lock your money into a five-year fixed deposit, it is important to note that, even if you only receive the interest on maturity, you will be liable for tax on interest each year as if you had received it. For example, if you receive 10% interest on a R500 000 deposit, your account will receive R50 000 in interest in the first year. Even though you do not receive the money, you would be taxed on any interest above R23 800 if you are younger than 65 and after the first R34 500 if you are 65 or older. The Fedgroup Secured Investment allows for partial withdrawal of the annual interest to meet your tax obligation.

If you are looking to diversify some of your money away from traditional bank deposits, there are two fixed interest options to consider. The RSA Retail Bond interest rate is priced off the long-term government bond market and is therefore not linked to the repo rate. Fedgroup Secured Investment invests in commercial property debt and, although priced off the repo rate, offers attractive interest rates.

Non-bank options

RSA Retail Bond – the restart option: 8% with upside

The fixed-rate retail savings bond series consists of bonds with two-, three- and five-year terms. Fixed-rate retail savings bonds earn a market-related fixed interest rate, which is priced off the current government bond yield curve, not the repo rate. For investors younger than 60, the full capital and interest is only payable on maturity. For those who are 60 and older, interest can be received monthly.

Currently, the rates are 6.50% for two years, 6.75% over three years and 8% for a five-year fixed deposit. Unlike traditional bank fixed deposits, the RSA Retail Bond offers a restart option, which allows you to restart your investment after 12 months if rates have changed.

For example, if you are invested in the five-year retail bond and the rate increases from 8% to 8.5%, you can select to restart your investment at the higher rate once you have been invested for 12 months. This is an attractive option for people who are worried that, if they fix their deposit for a longer period, they may miss out on higher rates.

Terry Msomi, director of bonds at National Treasury, says this could be a significant benefit if bond yields rise. Many investors are worried about a possible downgrade by Moody’s Investors Service, which would increase our bond yields because government would have to pay a higher interest rate to attract investors. A rise in bond yields would benefit investors in the RSA Retail Bond, which are priced of bond yields and not the repo rate.

RSA inflation-linked bonds: 3.75% above inflation

Unlike the fixed-rate retail savings bond series, total returns from inflation-linked bonds are linked to inflation. This ensures that, even if inflation rates increase, you will still receive a net real return.

The inflation-linked retail savings bond series consists of bonds with either a three-, five- or 10-year maturity. Capital amounts invested in inflation-linked retail savings bonds are inflation adjusted over the term, and a floating interest rate is payable every six months on the interest payment dates. Currently, the rates are 3.5% for a three-year bond and 3.75% for the five- and 10-year bonds. That means you are guaranteed a real return (after inflation) of 3.75% a year.

For example, if you invested R100 000 over five years and inflation was 4.4%, your capital amount would be adjusted to R104 400 over the year in addition to the interest earned. Interest is paid on the adjusted capital, so 3.75% would then be paid on the new capital amount of R104 400, which is R3 915. The capital adjustments are made twice a year – in May and November.

This product is specifically for individuals who want to receive an income and payments are made to investors on the biannual payment dates, which are May 31 and November 30 of each financial year.

There is a potential tax benefit for individuals as the full return is not paid as interest – only the interest portion that is paid would form part of your taxable income. The capital return could be taxed as capital gains, however, this would only be on maturity and is generally at a lower rate than personal income tax.

Fedgroup Secured Investment: 9% annual effective rate

Fedgroup Secured Investment offers a five-year fixed investment into participation bonds. It currently pays an annual effective rate of 9.11%, which equates to 10.93% on maturity. For investors who select the monthly income option, the nominal interest rate is 8.75%.

Fedgroup raises cash from investors to provide mortgages to commercial, retail and industrial property buyers. Fedgroup offers capital security and an attractive interest rate fixed over the five-year term with no fees.

In terms of risk, participation bonds are governed by the Collective Investment Schemes Control Act and fall under the Financial Sector Conduct Authority.

National Distribution Manager Angelo George says that, in its 30-year history, the company has not once forfeited any interest or capital to investors. It is also not to be confused with property syndicates, in which property is the underlying asset.

With participation bonds, the underlying security is in first mortgage bonds on commercial, industrial and retail properties.

George says Fedgroup has a very conservative lending policy and the total mortgage book is 51% of total property asset value. Any bond issued will not exceed 75% of the value of the property, and Fedgroup requires the owner to cede the leases, rental income and their personal surety to it.

Due to the investment being a collective investment scheme (unit trust), funds are pooled, so there is no link between a single investment and a bonded property.

While Fedgroup will consider movements in the repo rate, a bigger consideration is its 12-month outlook on interest rates and its demand for new mortgages.


Maya Fisher-French
Personal finance journalist
City Press
p:0117139001
w:www.mayaonmoney.co.za  e: maya@askmaya.co.za
      
 
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