Comparing interest rates is not simple, especially when comparing interest on maturity with annual compounding interest and nominal interest rates.

Take for example an advert for a five-year fixed deposit with 13.3% interest on maturity. In this case the annual compounding interest rate is 10.75% and the nominal interest rate is 10.3% – all for the same return.

So, if one bank advertises interest on maturity, another annual compounding and a third nominal interest, how do you know if you are getting the best rate?

Interest on maturity relates to the total interest you receive at the end of five years having left the money for the full period. You receive no interest income during the period as the interest is re-invested and starts to earn interest on interest. The interest paid on maturity is linked as much by the length of the investment, as by the interest rate paid by the bank.

The annual compounding interest rate is the effective interest rate over one year. The 10.75% annual interest rate means in one year a R100 000 investment would pay R10 750.  But if you re-invest, the balance grows to R110 750 and the 10.75% is applied to this new, higher balance. This results in more interest being earned in the second year of R11 905. If you re-invest that amount it grows the balance. Over five years, you would receive R66 600 in interest. By dividing that total rand interest earned by five years gives you R13 330 a year or 13.3% per annum.

Things get even more complicated when interest rates are stated as effective or nominal. As interest is actually paid monthly, there is a compounding effect even within a year.  “Nominal” is the annual interest rate before the benefit of monthly compounding.

In this example your nominal interest rate is actually 10.3% but this is paid as 0.86% monthly  so that each month the interest earns interest which means over a year your effective rate would be 10.75%.

The best way to compare rates is to compare the nominal interest rate, as that is the ‘cleanest’ comparison and is not affected by time.

For investment periods of less than a year, the bank will still show the nominal annual interest rate for comparative reasons, but your interest received would only be for the months you were invested.

If you are doing comparisons, ask the bank for a quote with the actual rand interest you will receive. This will make the comparison easier.

How interest on maturity works for R100 000