Is a five-year fixed deposit for you?

Where will South Africa’s inflation and interest rates be when your investment matures? That’s one thing you need to consider if you want to lock your money away in a long-term fixed deposit at a bank, writes

Banks are offering relatively high interest rates on five-year fixed deposits, and it may be tempting to invest in one. But make sure your decision is an informed one. Any investment has its advantages and disadvantages, and, depending on where we are in market cycles, some types of investment are more appropriate than others. You need to be fully aware of all the factors at play before committing your money.

Among the top nominal annual rates on five-year fixed deposits or similar fixed-interest savings products from banks are 10.25 percent at Capitec, 10.5 percent at Finbond Mutual Bank, 10.93 percent at Grahamstown-based GBS Mutual Bank and 11 percent at Standard Bank (for over-55s on deposits of less than R100 000; under 55s get 10.5 percent on amounts that can exceed R100 000).

On all these, the advertised rate is on interest paid out at maturity – that is, when the interest accumulates on your investment for the full five-year term. Some of the rates are on special offer for a limited period only.

Note that a nominal annual rate of, say, 10.5 percent, produces an effective compound rate of just over 11 percent a year, because interest is compounded at shorter intervals than a year – usually monthly. At 10.5 percent nominal (11.02 percent effective), an investment of R100 000 would be worth R168 660 after five years.

Lezanne Human, the chief executive of investment products at First National Bank (FNB), says on FNB’s blogsite that it is a good time to take advantage of the higher interest rates.

“Higher interest rates are often seen as spelling doom and gloom, but they’re actually good news for those who save in cash investments. Add to that the fact that all your capital and the quoted returns are guaranteed, and that you won’t lose any money should the markets crash, it becomes understandable that a portion of your money should be invested in cash.

“During times like these, when there is greater market uncertainty, it’s particularly important to build up cash reserves so that you have some level of savings to dip into should the need arise,” Human says.

The big disadvantage of a fiveyear fixed deposit is that you cannot dip into it: you should consider it only if you are comfortable with not having access to your money for the five-year period. If you are forced to withdraw before maturity, you are likely to pay a penalty.

Martin de Kock, a Certified Financial Planner and a director of Ascor Independent Wealth Managers in Pretoria, says although the interest rates look attractive at present, it is not advisable to lock in a large sum of money at a fixed rate for five years, and you should consider more flexible alternatives.

De Kock says the rates are consistent with the general consensus among investors and economists that economic growth will remain slow and that the next interest moves will be upwards.

“With that in mind, such an investment should prove to be reasonable over the short term (one or two years), where the effective rates are slightly better than the prime interest rate (10.5 percent). I fear that this will turn around for the remainder of the five-year period, where the effective return on such an investment could fall below the prime rate. Other investments could then become more appropriate options.

“Consider, for instance, if you invested that money in your home loan. You stand to save more over the five-year period as interest rates go up and your monthly bond repayments increase,” De Kock says.

“In the current economic climate, with such a high level of volatility and uncertainty, investing your money for such a long time could prove to be costly,” he says, adding that volatility creates investment opportunities that you would be unable to take advantage of if your funds were tied up. De Kock also warns about the possible penalties if you withdraw prematurely. “Penalties will hamper your investment growth if you withdraw your funds to invest in a product with a better yield,” he says.

INFLATION OUTLOOK

Whether or not you invest in a long-term fixed-interest product should depend to a large extent on what you envisage interest rates and inflation to be in the future. You will not have benefited much on, for example, a 10.5-percent-ayear five-year investment if, in five years’ time, the inflation rate is nine percent and interest rates have risen to 14 percent.

By raising or lowering interest rates, the South African Reserve Bank (SARB) tries to keep Consumer Price Index (CPI) inflation within a band of between three percent and six percent. This year, the CPI rate has climbed above the upper six-percent limit, and it is expected to climb further, although the May CPI figure surprised to the downside, at 6.2 percent.

A more optimistic view among economists, supported by longer-term SARB forecasts, is that the current upward inflation cycle will continue into the beginning of 2017, at which point it will turn, and inflation will again settle into the threeto-six-percent target range.

This is seen in a graph (see above) from Stanlib chief economist Kevin Lings, who says in a recent report: “The expected increase in inflation in 2016 is due to a combination of factors, namely, unfavourable base effects, a sharp increase in food inflation as a result of drought conditions and weaker exchange rate, higher electricity and water prices, the further increase in excise duties and the fuel levy that occurred in the 2016 National Budget, and an increased impact on inflation of the weaker exchange rate. Our inflation forecast model still suggests this risk of higher inflation in 2016 will manifest more noticeably in the second half of 2016, before dissipating in 2017.”

Lings told Personal Finance that inflation should peak at 7.5 percent, and its subsequent dissipation depends largely on the agricultural season returning to normal – that is, we don’t have another drought, which is unlikely – and the rand remaining at about R15 to the US dollar. In such circumstances, any double-digit return should have a favourable outcome, he said.