Time to consider a fixed deposit?

With a cut in interest rates likely, now may be the time to lock into a fixed deposit.

Looking to fix your deposit?Over the last 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 over 3% per annum. 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% per annum return for a five-year fixed deposit. At current inflation rates, that would be a real return of over 6% per annum which is the type of return expected from stock markets, not banks. Even the 24-month product is offering 8.5% which is well above inflation.

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 Basel lll requirements. This would be even more important to a smaller bank such as African Bank which is re-capitalising 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 while institutions move cash balances quickly as part of their cash management, retail investors tend to leave their money for longer periods of time. “Banks incentivise those 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.”

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 to lock in excellent long-term rates.

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 around 6.9%, though interest rates differ relative to institutions’ competitiveness. This rate is still relatively high for an investment that requires only 24 hours’ notice.

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

Hard to predict

The question is what will happen to interest rates over the next few years. What if you have locked in a specific rate for five years and rates increase?

Cele says predicting interest rates is very challenging. While South Africa appeared to be on a rate-cutting trajectory with inflation under control and a weak economy, the outbreak of the 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 USA announcing their biggest rates cut since 2008.

The bottom line is that these days, trying to guess what interest rates will do is virtually impossible in a volatile global environment.

Most banks offer fixed deposits that allow for interest-rate changes, but this usually comes with a rate sacrifice. Absa’s Dynamic Fixed Prime Linked fixed deposit will offer upside if rates increase, but currently pays around 40 basis points below the rate offered if you select a fixed interest rate, 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 to also consider non-bank alternatives.

Tax considerations

If you lock your money into a five-year fixed deposit, 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, in the first year your account will receive R50 000 in interest.

Even if you do not receive the money, you would be taxed on any interest above R23 800 if you are under the age of 65 and above R34 500 if you are 65 and older.

Non-bank fixed-interest options

If you are looking to diversify some of your money away from traditional bank deposits, a few non-banking institutions offer 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. OUTvest offers a fixed deposit wrapped in a 5-year endowment, which comes with tax benefits.

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

The Fixed Rate Retail Savings Bond series consists of bonds with two-year, three-year 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, and not the repo rate. For investors under the age of 60, the full capital and interest is only payable on maturity, but investors over 60 years of age can receive their interest 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 re-start 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%, once you have been invested for 12 months, you can select to restart your investment at the higher rate. 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 S Msomi, director of RSA Retail 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. This would increase our bond yields (as government would have to pay a higher interest rate to attract investors). A rise in bond yields would therefore benefit investors in the RSA Retail Savings Bond.

RSA Inflation Linked Retail Savings Bond – 3.75% above inflation

Unlike the Fixed Rate Retail Savings Bonds, 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-year, five-year or ten-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. Currently the rates are 3.5% for the three-year bond and 3.75% for both the five- and ten-year bonds. That means you are guaranteed a real return (after inflation) of 3.75% per annum.

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 aimed at those who want to receive an income. Payments are made to investors on the semi-annual payment dates, which are 31 May and 30 November of each fiscal year.

There is potentially a tax benefit, 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, which is taxed at a lower rate that personal income tax, and this tax would only be paid on maturity.

Fedgroup Secured Investment – 9% annual effective rate

Fedgroup Secured Investment offers a five-year fixed investment into participation bonds and 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%.  (Read this article to understand the difference between nominal and effective interest rates.)

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 (FSCA).  Angelo George, National Distribution Manager, says in its 30-year history, the company has never 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, retail properties. George says Fedgroup has a very conservative lending policy and currently the total mortgage book is 51% of total property asset value. Any bond issued will never exceed 75% of the value of the property and they require the owner to cede the leases and rental income in addition to their personal surety to Fedgroup. 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 take into account movements in the repo rate, a bigger consideration is their 12-month outlook on interest rates and their demand for new mortgages.

Fixed OUTcome Endowment – 7.2% p.a after tax

For investors who may already be receiving interest in excess of the annual tax exemption, the OUTcome Endowment from OUTvest could be a good option. It’s in effect a fixed deposit wrapped in a five-year endowment, so the returns are tax-free in the hands of the investor.

The company is utilising the deferred tax asset from OUTsurance Life. According to Grant Locke, head of OUTvest, the product offers new investors a return after tax and fees of 7.2% per annum. Locke says the rate has jumped almost 100 basis points in a week, as banks seem to be shoring up balance sheets in light of recent volatility. As with a typical fixed deposit, the interest is rolled up and paid out at maturity.

 

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