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When 13% interest is not really 13%

Absa’s special offer is not what it seems at first glance.

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%.

Further questions

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.”

Potential risks

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.

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Good article. It’s actually around 10.5% pa, if interest is taken annually, compounding to 13% effective after 5 years. But certainly misleading advertising.

Nevertheless, after investigating myself over the past few days and looking at the actual rates, I’ll still be putting some money in there later today. And sorting out the CGT on the old investments next year.

As you say, Patrick, it’s still a great rate. So are their 2 year and 18 month rates. Would just be nice if they were honest and open about the realities of the numbers, so non-financial people could compare options properly. Would be wonderful if all other banks would do the same.

Apart from the misleading advertising there is also a tax effect.

The total interest earned will be the same whether you get 13% at the end or 10.5% compounded annually, and all things being equal you will also pay the same tax over time.

However, because interest s accrued quocker in the first couple of years on the non-compounding 13% basis, you will also pay tax earlier.

Do you really want to take the bet that the USD/ZAR devaluates by less than 10% pa over the next 5 years? Very brave.

Couldnt agree more no brainer.

I am tired of these banks offerings! I HATE hearing you can get “UP TO” 11% etc… That up to phrase MUST BE TAKEN OUT OF THE INVESTMENT INDUSTRY!!

Also beware of the taxman who will take a large chunk in taxes on the interest you earned leaving you poorer.

Which is why I laugh at the whole ‘compounding interest’ argument. When you reach the tax threshold (last time was 15k pa interest) tax kicks in nicely and you won’t reach the theoretical target.

In SA, no-one really wins

I.e. Take your money abroad. Where I don’t know… yet. Maybe that can be an idea for an article for the future? I certainly would like to read it. 😀

Your threshold is seriously outdated. At the moment the tax exemption on interest is R23,800 for taxpayers under 65 and R34,500 for those who are 65 or older on the last day of the tax year. At 10.53% p.a. (the actual annual rate over the five years) that equates to a capital investment of just over R226,000 and R327,500 respectively, assuming you do not hold any other interest bearing investments.

@bobsmith. “…last time I checked it was R15K annual interest exemption”

*lol*…I know exactly WHEN you checked last time…in 2005/2006 tax year 😉

Sorry for the mock/chuckle bud…

…but in fairness, that R15K tax-free interest back in Feb 2006 per persons under 65-age, is probably WORTH MORE than the R23,800 tax free today (in real terms).

As most home owners with a bond are paying around 10.5% interest, the best and safest way to invest spare cash is into your access bond. That will compound tax free, be flexible in terms of the interest rate which will surely increase and be readily accessible. No brainer really.

Until such time as you have no bond to service. Then it becomes a very different ball game. The search for yield is now very real in S.A. as it has been abroad for the past 10 years.

They take your money, pay you 10% interest then lend it to others and charge them 18-20% interest via loans, credit cards etc

Yes, shocking isn’t it? Retailers do it too – they make a margin on stuff they get from wholesalers. And the wholesalers are marking up stuff they get from manufacturers!

Crazy how all these companies have the cheek to make a fair return!

If that’s what you call fair

ABSA is no exception. Nedbank had the same offer 2 years ago. You should have seen the faces when I asked whether is was simple or compound interest. It took a few phone calls before I got the answer. Even their head office took about a week before I received a reply.

Absolutely. The mere fact that you earn/save interest at a guaranteed rate, risk-free makes it a great investment, but what makes it even better and gives me the greatest personal satisfaction, is that SARS cannot touch a cent of the interest saved.

Above comment was in reply to boomgloom

I remember the Nedbank Green Savings Bond offering in 2016. Same basis as the ABSA offer, attracting same criticism

This is blatant lying by ABSA and a deliberate attempt to mislead the most vulnerable South Africans, those looking for a better yield on their fixed incomes. The statement that they “deliberately chose 13%” means they knew exactly how they were manipulating the differences between effective and nominal interest rates to lure customers who can’t do the maths. No matter which way you cut this, the return to the saver is 10.05% per annum and NOT 13%. To expect the ASA to pick up ABSA’s dishonesty is disingenuous. ABSA deserves an official reprimand and it should apologise for its lying to the public.

So ethical …: In a country with MANY regulations and MANY useless enforcers – practically anarchistic (how many looters and arsonists have been sentenced?)
It seems to be OK for them to mislead as long as no ‘authority’ picks it up or do something about it?
Just read this shameful response again:
“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.”
Do they hear themselves speaking? Where has ethical conduct gone? But this is African-icity on the move … contagious.

Hi John,
I have just checked they do not offer a annual interest rate which I would have preferred. This offer is only on there Fixed Deposit and the rates do not apply to there Dynamic products. Same applies to Capitec ether monthly or end of term will result in huge tax implication. Under 65 R23700 and from 65 R34500.00 interest before being taxed.
Wally

The 13% per ABSA’s full statement is EFFECTIVE interest, upon 5 yr maturity.

Did a calculation (using excel formulas)…but using INTEREST COMPOUNDED DAILY approach (what would apply to most investment & loan principles out there) in order to arrive at R150,000 + R97,500 = R247,500 maturity amount (IF that’s assumed correct, Patrick)…one ONLY need 10,0% SIMPLE/NOMINAL interest, compounded daily, to arrive close to R247,5K.

…that’s even lower than ABSA’s own admittance of using 10,5% nominal/simple interest…hmmm.

(As someone mentioned, this is for pensioners or investors that doesn’t have debt to service at a higher %)
Personally, I do not prefer too long Fixed Deposit type investments…especially in a raising interest rate environment (globally also, SA just lags it). I consider 18mnth to 2yrs max, being still a good % rate, just a bit lower…and more freedom to later lock in at a higher % much sooner.

As with other financial institutions like Sanlam, Absa is actually just indicating that they are that confident that the rand will devalue by at least 13% pa over the next 5 years.

There are a number of things that come into play here.

If the banks and investment houses are that certain that it will devalue, then they will act in a manner (taking money offshore) that will in fact cause the Rand to devalue.

If the rand is going to devalue by that amount, and you get jittery when it plummets, will you leave your cash lying in that account? i.e. If you draw it you wont get the return, but Absa will still have had time to make their money of the money that you gave them to hold for you.

If there is a run on the banks when the Rand plummets, do you think you will be able to get your money back that quickly? Read the fine print of your banking contracts. The laws have changed since the Saambou debacle.

People are sheep with short memories.

the rand has shown an average depreciation of 6.8% per annum over the 37 year period 1981 to 2018. Hence a net depreciation of about 38% can be expected over the next five years. Due to the volatility of the rand however, that depreciation could be anything between say -10% to +60%, but it will continue to depreciate by over 6% in the long term.

You invest based on historical performance right?

It really is a big problem. A lot of companies are quoting simple interest investment returns. The reality however, is that the majority of people don’t know what simple interest is. This includes the employees of the companies offering the investments.

Granted, 10.05% compound return is not bad compared to what our shares have been doing the last 4 years. The concern is regarding transparency, especially if the capital is locked in for 5 years. Fedgroup is doing the same thing with their alternative and secured investments as mentioned below:

https://tigersonagoldenleash.co.za/2018/09/22/tripping_bees/

I’ve always understood that it was compulsory to specify the annual interest rate, and whether the nominal or effective rate.

Interesting this one, normally a financial institution would have a product approval committee that would deliberate around, how a product goes to market. Wonder if the ” new brains trust” at this institution have applied themselves.

Ahhhh ABSA you wicked beauty…

What happens if an investor needs to access their money before the period is over?

This will however incur a fee, and it will only tell you what that fee is if and when the time comes.

Usual Banking/Financial industry shenanigans,, morals don’t enter the picture.
Add ones tax angle into the formula and its not attractive at all.

I agree 100% with Mr Bustin’s take on this. ABSA are undoubtedly and deliberately misleading people with their advertising – and they do this knowing full-well that most people will NOT read the fine print and will be drawn by the number “13%”. ABSA ALSO knows that unless there are specific complaints lodged against them for this, regulators will do NOTHING about it – Notwithstanding the fact that 10,5%pa is an excellent rate in the current economic environment, I sincerely hope that regulators NOW sit up and take notice because there will be lots of misunderstanding about this that will only “explode” a year-or-more into this investment when people might be forced to access their funds.

Hiding behind shrewdly-worded fine print is all-too often a sneaky modus operandi practised by large organisations.

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