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Is Finbond really paying 15.5% interest?

Well, no.

Given the current low return environment, a bank offering 15.5% interest on a fixed term product sounds incredibly appealing. After all, there isn’t a single multi-asset high equity fund in South Africa that has given investors even a 10% annualised return over the past five years.

So it’s not surprising that Finbond’s ‘guaranteed fixed term interest bearing note’ that offers an ‘effective rate’ of 15.5% over five years has caught the attention of many investors. The minimum investment of R1 million might put it beyond the reach of a lot of people, but it still sounds like a tantalising offering, particularly for anyone looking for somewhere to put a large pot of retirement savings.

As the below advert shows, however, Finbond has actually linked two different rates to the product. The 15.5% is obviously being promoted given its larger positioning, but there is also the rate of 11.5%, which it calls ‘simple interest’.

The difference is significant, and investors should appreciate what it is.

The 15.5% is promoted as an ‘effective rate’. This is a confusing term that a number of banks have been criticised for using for a number of years now. Most recently, Absa’s 13% fixed deposit rate attracted a lot of scrutiny.

Read: When 13% interest is not really 13%

The reason that this ‘effective rate’ is problematic is that it is calculated using a bit of reverse engineering. This is illustrated in the table below.

The product is actually paying an interest rate of 11.5%. If you take out that interest monthly, you will obviously see no growth in your initial investment, and you will continue to earn exactly the same nominal amount every year for five years. This is shown in the first two columns.

If, however, you elect to reinvest that interest, you start to see the effect of compounding. You will earn interest on your interest and therefore begin to see the nominal amount of interest grow each year. This is shown in the second two columns.

Illustrative R1 million investment
  Interest taken monthly Interest reinvested
  Capital Interest Capital Interest
Year 1 R1 000 000.00 R115 000.00 R1 000 000.00 R121 259.33
Year 2 R1 000 000.00 R115 000.00 R1 121 259.33 R135 963.15
Year 3 R1 000 000.00 R115 000.00 R1 257 222.48 R152 449.95
Year 4 R1 000 000.00 R115 000.00 R1 409 672.43

R170 935.93

Year 5 R1 000 000.00 R115 000.00 R1 580 608.37 R191 663.51
End capital R1 000 000.00   R1 772 271.88  

What Finbond has done to get to the 15.5% ‘effective rate’ is to calculate the total growth on compounded investment amount (shown at the bottom of the third column). It has then divided it by five and compared it against the initial capital amount and expressed this as a percentage. This is shown below.

 Finbond’s calculation  
End capital R1 772 271.88
Total interest R772 271.88
Divided by five R154 454.38
As a % of initial capital 15.45%

This is not, however, interest. It is not even an internal rate of return. Hendrik Bester, a retired actuary and former CEO of Sanlam Asset Management, argues that it is “a totally nonsensical calculation” and “no recognised measure of return”.

Crucially, there is no other type of investment that uses this kind of measurement. In other words, 15.5% is not comparable to anything else.

“What they are offering is 11.5% per annum, compounded monthly in arrears, which yields an effective rate of 12.1%,” Bester argues. “They calculate the maturity value correctly, but they portray the 11.5% compound interest as if it is in fact effectively 15.5%. The terminology is used out of context and is purposefully designed to mislead investors.”

Finbond responds

Finbond CEO Dr Willem van Aardt doesn’t see it this way. In a response to Moneyweb he argues that:

“Our advertisements for the interest-bearing note makes it abundantly clear that the rate is 11.5% calculated on a simple interest basis, and in the event that the client elects to have interest capitalised over the term of the product and paid out only upon maturity thereof, then the interest compounds monthly, which means it is added to the capital balance of the note, and the effective rate earned works out to just under 15.5%. Both the simple and effective interest rate is 100% transparently disclosed in all our advertisements and documentation (unlike some other banks that only advertise(d) the effective rate).”

Van Aardt did not however answer questions as to why, if Finbond acknowledged that the 11.5% rate is the actual interest rate, the 15.5% is advertised at all. After all, 11.5% is still an extremely attractive return. So why does the bank feel the need to promote a different, and inherently confusing, rate as well?

He also did not respond to Moneyweb’s request to explain why Finbond would use this kind of calculation when other banks have been consistently criticised for similar practices. Nor did he answer whether Finbond is not creating an unfair comparison with other products.

On the whole, investors should be wary of anything that is sold as an ‘effective rate’. This is not a standard measure of return and is inevitably going to make comparisons with other products very difficult, or even impossible. The ‘simple rate’ is always the true measure of interest being earned, and that is where investors should focus.

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COMMENTS   27

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Investors beware. Strange and unique ways of calculating interest designed to appeal to your greed and entice you to give this mutual bank your money should be a WARNING to you.

Historically when a company offers much higher interest compared to its peers,
it might be a sign of the company struggling.

Defiantly. The higher the return the higher the risk……

Yes, RULE9, I agree with you, but it is also your responsibility to do the basic calculations:

Based on:

1. The interest rate of course
2. The period of the investment
3. WHEN the interest is calculated (monthly, yearly, at the end of the period?)
4. Simple Interest or Compound Interest?

To compare to other investments, you use the above to calculate the value
of your capital amount PLUS the interest.

This was done in this article, and if every investor actually calculated
this, there would be no reason to publish this article!

I am not attacking Banks, they are doing their jobs, but this is no different from The Carbonaro Effect:

A friendly greeting in the beginning by an open and honest boyish face, and terminated by an “I Got You”, with a lot of BS-magic (or Cara in Arabic) inbetween.

The bigger question is what is the risk investors are taking. The deposits are used to finance micro lending. Think loan sharks. Bank assets are around R1.4m. Money lent out over R5bn. This is by no means a bank that cannot fold. Just know that for a bank to offer a high return risk is high. A bank guarantee is only valuable if the bank has a strong balance sheet. This is a tiny little bank.

I am assuming that you have a typo and mean R1.4bn and not million.

If they lending more than they have in deposits then that means they must have another funding source such as bonds or other facilities.

I am fairly certain that deposits would rank equally or ahead of other funders, if this is a subordinated product then it really needs to be clearly marked.

You are making a bunch of assumptions, I have not had a detailed look at their financials and yes they are a small bank but being in the micro loan business does not automatically make you a small risky bank. The quality of that book is what is important.

I see banks as the graveyard of money, where your money dies a slow, but sure death. Not for the banks of course, but for the depositor.

Good one, Danie!

…and add to that, the JSE is the graveyard where local equity investments die? (“circa 2015”) 😉

So where would you invest?

Dayview, I think I should perhaps try Gold derivatives for a change 😉 Bitcoin is too risky…

The real risk with Finbond investments is in the source of their income , which consists mainly of high risk loans in the micro loan industry . Globally , companies partaking in the micro loan industry have a high failur
e rate . The largest micro loan company in Britian became bancrupt this year .
Long term investor , and especially pensioners , should not invest in such a high risk investment bank .

I’ve done the calculation using simple math.
Five payments of R115K + the end capital equates to an effect annualized return (IRR) of 8.5-8.7%, nothing better than the average bond fund.

Although I understand the uproar, this is really semantics. IRR is effectively your return. The only issue being the comparability of this product.

You could use a CAGR approach to a fixed term product, that’s how I would assess it.

I would like to assume that if you are placing R1m+ in a product like this then you are doing a good comparison of products with multiple methodologies to make sure you max your returns.

Unfortunately your assumption would be wrong. Most people do not take the trouble to properly analyse what they are investing in.

The 15.45% is the simple interest rate per year over 5 years,
calculated at the end of the five years.

VS

The 11.5% is the compound interest rate,
calculated at the end of each month.

MJ:

No, you can’t just take the initial million as the capital. At end of year one your capital is actually 1.15m. At end year two your capital is actually 1.243m etc. to quote a return on the initial advance only should constitute a crime in the finance sector.

Take their approach forward to a 20 year term to understand just how misleading and false it is. If they don’t understand this they should not be in the finance business.

I shudder to imagine what the poor people that borrow money from this loan shark actually pay versus what they are told they pay. I suspect the same trick is used in reverse. Borrowers are probably deemed to only repay interest and insurance fees and origination fees and commission and admin fees until the last few payments!

Thanks Patrick. Your contributions are always interesting and pertinent.

And watch out for the taxman. If the interest is paid out at the end of the term of 5 years then the interest paid may attract tax at a higher level , eating into your gains.

Indeed, you’re correct. Tax on local investment interest is another factor, when it exceeds R23,800 / R34,500 level for Individuals under/over 65-age.

However, one good thing is one will NOT pay tax on the (combined/aggregate) interest upon maturity, but rather the interest “accrue” each tax year of the investment….so one can benefit form the annual R23K p.a. interest exemption a multiple times over the 5yr term.

The bank will issue an “IT3b” tax cert, every year you earn interest, irrespective if you withdraw the interest or not. It accrues annually, hence taxable. Interest-exemption spread over 5 years will be more beneficial otherwise 🙂

If you’re Community of Property married, both spouse’s interest is split 50/50. If married ANC, you can transfer some capital to your spouse, so that the spouse can utilise his/her interest-exemption as well.

Reckless advertising.

Even 11% is more than reliable financial institutions are offering.

In addition, Someone once said “If it sounds too good to be true then most likely it’s not true.”

I was under the impression that even if interest is paid out at the end of 5 years one still has to pay tax on the interest annually.Maybe I’m wrong.

Just let Finbond join the list with ABSA and Standard Bank of dubious providers of spurious interest rates calculated in a way nobody with an inkling of education would allow. This is dishonest, misleading and should be stopped.

It is necessary to compare only nominal rates. “Effective” rates can vary according to compounding periods, whether annually, monthly, daily or more frequently. Just for interest, or rather (to avoid the bad pun) for amusement, try using one minute in your PV-FV return calculations. This is a shocker.

It seems that Finbond CEO Dr Willem van Aardt didn’t go to money school, or is trying to deliberately mislead the people. A CEO should know better than to try this short-term gimmick – Finbond will lose customers over time when they find they’ve been misled.

The issue is quite simple:
1) This is not an acceptable way by any stretch of the imagination to quote a return and appears to have been invented to push product
2) They are DELIBERATELY and MALICIOUSLY deceiving the public … Let them explain how this type of advertising passes TCF and basic common respect for your potential clients?
3)Possibly contravenes the code of conduct under the FAIS act… maybe the newly constituted FSCA should start with this one?

A rational and moral investor would not p on this crowd if they were in fire

Foxes!!!! I am personally not surprised to be informed that Finbond does this but I am disappointed to hear that ABSA also did it as I normally have reasonable trust in ABSA. Why is this kind of misleading advertising not illegal? I am greatful for journalism that exposes it.

This house of cards has started to tumble, just look at the share price.

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