July 26, 2008
 By Bruce Cameron
Interest rates you can earn are now at recent highs. They aren't likely to go up much further following the recent row between Investec and Statistics SA over the accuracy of the current inflation rate; the introduction in January of a new way of calculating inflation, which is expected to result in a sharp drop in interest rates next year; and the fact that high interest rates are starting to bite, also contributing to downward pressure.
This means you need to be thinking about whether you can take advantage of the current high rates.
What is clear is that when interest rates are high, very few people benefit from investing in money markets for the short term. The reasons for this (as pointed out in our lead story today) are inflation plus tax. These two factors will reduce the real return you receive. The higher your marginal tax rate, the worse off you are.
You are most likely to benefit from short-term interest-earning investments if you are in a low-income tax bracket or if you have not used up your interest exemptions from the taxman. This exemption applies to the first R19 000 you earn in interest in a tax year if you are under the age of 65, and to the first R27 500 if you're 65 or older.
As Peter Brooke, the head of macro strategy investments at Old Mutual Investment Group (Omigsa), warns in today's lead story, it's not a great idea to cash in your equity market investments to take advantage of short-term interest rates.
This, however, doesn't mean that you should not be giving the high interest rates a great deal of attention if you're on a fixed income. They can be used to your advantage in the long term. But you need to take account of a number of factors. They're all important and have played off against each other. Here they are in no particular order:
The amount
The greater the amount you have to invest, the more you can negotiate for a better rate. Also, many bank deposit or term accounts have scaled interest rates offering a higher rate for greater amounts of cash.
The tax you pay
Tax can affect you in various ways. The higher your marginal rate of income tax, the more you reduce your returns on interest earnings. There are, however, exemptions.
Over recent years Finance Minister Trevor Manuel has been pushing up the interest rate income tax exemptions very much in line with inflation. This means that you should make a conservative estimate on how these exemptions will increase and the impact of your marginal rate on future balances invested in taxable interest-earning financial instruments.
Interest rate
Interest rates vary according to the amount you invest, your investment term and the type of product you select. Different products have different average interest rates. For example, you are likely to receive a better rate from a unit trust money market account than from a bank money market account on money invested over the short term. Products within the generic range, such as unit trust money market accounts, will also vary. Then there are the anomalies. At times such as these, very short-term interest rates (30 days to six months) can be lower than medium-term rates (12 to 24 months) and then higher over the longer term (five years plus).
Interest rates are subject to many different forces both for short-term and longer-term investments, which often make them look out of kilter.
The main issue is what money market investors expect interest rates to do in the future. You should also remember that fractions of a percentage point can have an impact on what you will receive over the longer term. You need to take the time to shop around for the best rate.
The term
As pointed out, your investment term will affect how much interest you earn.
Currently, 11.25 percent interest on the five-year RSA Retail Bond may not look great against 12.77 percent you could earn on the Cadiz unit trust money market account. Nor does it look that great compared with the 12.65 percent (Bidvest) you could get on a 12-month bank term deposit. A two-year RSA Retail Bond paying 10.5 percent definitely does not look good against Absa's rate of 12 percent over 24 months.
But the five-year RSA Retail Bond rate is actually more attractive than it may seem. In our front page report we quote Rian le Roux, the chief economist at Omigsa, as saying interest rates are likely to have peaked. So by the end of next year interest rates being paid on money market accounts could be considerably down on the rates offered by the RSA Retail Bond. Suddenly the real after-inflation, after-tax return of the five-year RSA Retail Bond will start looking decidedly attractive.
The product
There are a number of products you can use to lock in long-term interest rates in your favour. Interest-earning investments are not restricted to products like the RSA Retail Bonds and bank term deposits. You need to consider bonds and annuities.
Bonds are long-term borrowing instruments used by big institutions, such as governments and utility companies (Eskom and Telkom), and big companies. In very simple terms, bonds pay higher rates (known as the coupon) when there's a shortage of money available or when it is anticipated that long-term interest rates will increase.
Long-term interest rates start falling when there is more money available or when it is anticipated that it will be available. The only problem, however, is that you need at least R1 million to invest directly in the bond market. RSA Retail Bonds are actually a subset of this market rather than pure short-term interest-earning investments.
An annuity is any regular income from any source. Over the years it has come to mean a pension, normally one bought from a life assurance company with the proceeds of a tax-incentivised retirement savings instrument. This type of pension is known as a compulsory purchase annuity (CPA), but you can also invest in what is called a voluntary purchase annuity (VPA) which you can buy with any money.
A CPA is guaranteed for life and must be bought for life, while a VPA may have different levels of guarantees for different periods. Both come with different bells and whistles.
Annuity rates are mainly based on long-term interest rates and your age. The older you are the more you receive (because you're expected to die sooner).
When long-term interest rates move up, so do annuity rates. And the great thing is they lock in. So if you buy a guaranteed annuity when interest rates are low, your pension will be less than if you buy when interest rates are high. And your pension will be locked in at that level for the rest of your life (unless you bought a short-term VPA).
This is a great time to buy an annuity. Again, annuity rates vary between companies so you must shop around.
Published in the latest edition (3rd quarter 2008) of Personal Finance magazine is an in-depth article on the impact of age and interest rates on annuities. If you're contemplating buying an annuity, don't miss this issue of the magazine. You will find it very useful.
So in a nutshell, whether high interest rates are a boon for you, as an investor, depends on your needs, the real rate of return and the products that you select.
Pssst ... keen to make a quick buck?
Want to make R2 million from R100 in two years? On offer this week was one such "guaranteed investment".
The offer, distributed via email, was made by someone who will identify himself only as "Randhir" from North Riding in Gauteng.
He sent out a blanket email boasting of an "investment opportunity" called Expedia Investments offering a guaranteed return of 10 percent a week.
Included on this mailing list was Errol Kruger, the Registrar of Banks. This was surprising as Expedia Investments has all the hallmarks of contravening the Banks Act.
But even with all the hallmarks of a scam, it seems people couldn't wait to give him their money.
According to an email interchange between Randhir and Personal Finance, some people did part with their money.
Fortunately, more people took his offer for what it was and reported it to Personal Finance and the authorities.
The Financial Services Board (FSB) and Reserve Bank are investigating.
The sales pitch
This is some of what Randhir told his potential victims: "We are looking at people that can join us [investing] from as little as R100 and earn up to 10 percent per week. There are no catches. We have developed a trading system so powerful and RISK FREE and want you to be part of it.
"We use the simple process of arbitrage trading. We trade a variety of markets scanning them daily for hours and immediately trade once our filters are met.
"The arbitrage trading literally means 'Risk Free Profit'. A similar concept can be extended as 'Free Lunch' or 'Free Money Making Machine'. Across the globe, traders and market makers attempt to get this risk-free profit while attempting to do arbitrage trading. Simply it means covering all outcomes of an event to ensure a profit."
Arbitrage trading is the practice of looking for mis-priced investments. And it's definitely not risk free. Ask the former owners of Barings Bank, which collapsed in 1995 under the strain of the rogue arbitrage trading of Nick Leeson.
Randhir admitted that, in effect, he was betting on sports events. So much for no risk.
The people who did invest in Expedia missed many of the warning signs of a scam. These include:
1. Massive returns. No investment will give you a return of 10 percent a week, not in the short term and definitely not in the long term. Garth Taljard, an actuary from Old Mutual Investment Management, also received the email. Taljard has calculated that if you invested R100 now you would have R2 million by the World Cup kick-off in 2010. Interest of 10 percent a week adds up to 14 104 percent a year. Randhir says he can make 15 percent a week and keep five percent for himself!
2. Absurd guarantees. No such investment could be guaranteed.
3. No proper registration. In terms of the Financial Advisory and Intermediary Services Act, anyone selling a financial product must be registered with the FSB as a financial services provider. Expedia Investments is not.
4. Contravention of laws. Randhir was intending to pool the investments, but Expedia is not registered in terms of the Collective Investments Control Act. No one can raise money from the public without a prospectus, which must be issued to all investors and lodged with the Department of Trade and Industry. This is a contravention of the Companies Act. And in terms of the Banks Act, no one may take money from the public without it being raised within the prescription of other financial laws.
5. No contact details. Expedia Investments does not provide telephone numbers or a physical address on its website or email. This is a dead giveaway.
Expedia reeks of being a Ponsi or pyramid scheme, whereby money collected from the second batch of investors is used to pay returns to the first batch who create a frenzy that attracts wave after wave of investors who want to get in on the act.
As soon as the Ponsi operator suspects he's going to get caught he disappears with the money.
Randhir claims he's not crooked - just ignorant of the law. And he still seems to be believe he was offering a great investment opportunity.
He says he has paid back all the money he received apart from one amount, which he can't repay because his Standard Bank account "is suddenly not available".
  
 
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