Absa is currently offering 13% per annum on five-year fixed deposits of R100 001 or more. In the current environment of low returns, that seems like an astonishingly attractive proposition.
Until one reads the fine print.
The caveat is that this is not compound interest. Absa is stating the return in simple terms: the 13% is earned purely on the initial capital amount.
For an investment of R150 000, that means that you would effectively earn R19 500 per year, each year. At the end of five years, that gives you R97 500.
Which is the second important part of the equation. You only see that full amount if you don’t take any interest during the life of the product and only receive it as a lump sum at the end.
What you’re really earning
Objectively, this is still an excellent return and well ahead of what is available from any of Absa’s large competitors. It represents a guaranteed compound interest rate of 10.05%, which is around 5.0% above inflation.
The question that has to be asked, however, is why Absa wouldn’t just state it in those terms in its advertising, as it does quite clearly on its website.
“For advertising purposes, we had options of whether to position 10.05% or 13% per annum,” says Cowyk Fox, Absa’s managing executive for unsecured lending at its retail and business bank. “We deliberately chose 13% to provide maximum benefits to customers who are able to be resilient to afford a 60 month investment period.”
Customers could still take the monthly interest if they want to. This would be paid at the real rate being earned in this product of 10.05%.
What has raised more eyebrows about Absa’s offer is the environment in which it is being offered. The bank must be aware that investors are feeling the stress of poor equity market returns over the last few years and that pensioners in particular are growing concerned about the sustainability of their income.
A 13% return from a big bank is going to be good enough for many people to move their money without scrutinising the fine print or receiving advice on the related consequences.
“In the current economic environment, where pensioners are battling to make ends meet and where they are frightened by the noise about market risk, 13% is such a drawcard,” notes independent financial advisor John Bustin. “Regrettably, many pensioners are going to end up locked into an inappropriate investment.
“If it were expressed as 10.05%, many of these folk would apply their normal caution when assessing this offering,” he adds. “But when pensioners are between a rock and a hard place when it comes to their dwindling income, this 13% is so attractive that human nature tends to switch off the normal caution that is applied when deciding whether to restructure your retirement capital.”
As Bustin points out, first among the potentially unseen risks is that South Africa is entering a rising interest rate cycle. A locked-in rate of even 10.05% might sound good now, but is still going to be that attractive if the South African Reserve Bank (Sarb) lifts rates by 2.5%?
Absa’s response is that, actually, the Sarb’s last change was to lower the interest rate. It also encourages potential customers to get advice, even though this isn’t required.
“Our decision to run this campaign is maximally beneficial to our customers,” Fox believes. “Any assertion to the contrary isn’t based on objective facts. The competitive nature of the campaign is clear in the rates we have offered.”
Bustin’s second concern is that if anyone moves money out of another investment to take advantage of this offer, will they consider the capital gains tax they might have to pay? That has to be factored in when considering the actual return.
In addition, if anyone wants to take advantage of the full ‘13%’ offer, that means that they will receive a lump sum payment after five years. As this is interest, it will be considered income and taxed as such. Not only could this result in people finding themselves lifted into a higher tax bracket, it could substantially erode the return.
Finally, as with any fixed deposit, what happens if an investor needs to access their money before the period is over? Absa’s terms and conditions note that in exceptional circumstances, and at the bank’s discretion, it will allow you to end the investment before the term is up. This will however incur a fee, and it will only tell you what that fee is if and when the time comes.
Is it misleading?
Bustin believes that all of this is compounded by the way Absa has chosen to advertise the rate.
“In reality, 10.05% is an excellent fixed deposit rate, and a deserved home for certain investment needs,” he says. “But expressed as 13%, without disclosing that it is simple interest, is misleading no matter how you skirt around it. The defence that it is fully explained on the website may be legally valid, but not morally.”
Absa’s response to this is that if the campaign was really misleading, the authorities would have spoken up:
“Our fixed deposit campaign is a deliberate endeavour to forge lasting relationships between us and our customers by creating an optimal mutual benefit for both,” Fox argues. “We also believe that customers are generally reasonable enough to detect any attempt to mislead them. We believe that the Advertising Standard Authority of South African would have already approached us had we been seen as misleading our customers.”
Read Absa’s full statement here.