With the turmoil in the markets and increasing interest rates, it makes sense to keep your hard-earned money in cash. While we do agree with this concept, to an extent, the turmoil also creates wonderful opportunities to buy ‘cheap’ assets. That however is not the point of this article.
Cash is a necessary asset class for various reasons, for PWH Wealth Group it provides a relatively safe space for client’s “emergency” funds. Although PWH does offer cash solutions through Investec, we understand that our clients like to have their own private “stash”.
Background and definitions:
Interest Rates: There are two types of interest rates in short, one that the bank pays to depositors and the other that the bank charges to lenders. The raising of interest rates is a tool which is used by central banks to curb inflation. Interest rates will generally work in cycles depending on what a treasury/ government is trying to achieve; this could include inflation targeting and/or it could be to change the price of a currency. Whatever the reasoning, interest rates will fluctuate.
Gross and Net Interest Rates: Interest rates are quoted as gross interest, meaning that this is the rate paid before the deduction of tax. Net interest is the rate of interest after tax.
For example:
Gross Interest Rate: 10%
Tax Rate: 45%
Net Interest Rate: 5.5%
(10% x 45% = 4.5; 10% less tax (4.5%) = 5.5% (Net return/ Interest rate)
Income Tax on interest is generally more expensive than Capital Gains Tax and Dividends Tax.
Compounding: If you invest in a deposit account and earn interest, when you draw on the interest, you are earning the quoted rate of that deposit. If you reinvest the interest or leave it in the account to earn additional interest, you will effectively earn a higher amount of interest due to the effect of compounding. This will result in the same interest rate being applied to a higher amount each time interest is paid into your account.
There are a variety of different interest-bearing accounts and it is important to understand certain factors:
1. How often is the interest paid? Daily, monthly, quarterly or annually. The frequency of payments will affect the rate of interest your money is attracting. Interest or deposit accounts that apply a daily interest rate will offer a compounded return for the year, where an annual payment, gives you the set rate.
For Example:
A deposit of R10 000 each into two different accounts:
Account A pays an annual rate of 4% (paid annually)
Account B pays an annual rate of 4% (paid quarterly at 1%)
Account A = R10 000 x 4% = R10 400
Account B = Q1 R10 000 x 1% = R10 100
Q2 R10 100 x 1% = R10 201
Q3 R10 201 x 1% = R10 303.01
Q4 R10 303.01 x 1% = R10 406
If the investor had invested in the quarterly interest account, they would have benefitted from the compounded effect. It is important to compare like with like when deciding on a deposit account.
2. Fixed Interest Rate or Variable? Are you getting a fixed interest rate for a specific term or will it fluctuate as the interest rate changes (REPO rate).
3. How much liquidity do I have? There is an array of options on liquidity; you can tie your money up for a set term, for example, 1, 3 or 5 years at a fixed or variable interest rate.
4. What is my real return? Real returns are calculated as the interest rate less the inflation rate For Example:
Interest rate 6% - Inflation rate 8% = -2% real return. Do not forget that the interest is still taxable.
It is important to consider what you are putting your money into and to ensure that you understand the T&C document. In general, the longer you lock your money in, the higher the interest rate you will get. However, it is possible for short-term interest rates to be higher than long-term rates.
Questions to ask before you commit:
What is the Effective Interest rate per year?
Is the interest rate fixed or does it fluctuate with changes in the REPO rate?
What liquidity do I have?
What is the forward inflation rate projected to be?
To conclude, PWH Wealth Group has partnered with Investec to offer our clients competitive cash returns over a variety of deposit terms and notice periods as you would get through your bank. Please contact us for more information.
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