Question:

Why would anyone in their right mind have a fixed deposit at a bank when RSA Retail Savings Bonds cost less and yield more?  Or am I missing something?

Answer:

The biggest difference between these two savings options, and the one that impacts the rate most noticeably, is that of duration.  In other words, the time period your money is committed for.

Most banks offer fixed deposits of terms between three months and a year; RSA Retail Savings Bonds, on the other hand, start at a minimum of two years with options of three years and five years as well.

The common trend you will notice on both instruments is that the rate increases with the duration. By way of example, a current three month fixed deposit may yield around 5.12 percent whilst a one year deposit will yield around 5.48 percent. Similarly, the RSA Retail bond with duration of two years will yield 6.75 percent as opposed to 7.5 percent for five year duration.

The reason for the rate difference (aside from multiple calculations) is that of opportunity cost. With any fixed rate instrument you are taking (or accepting) a bet on future interest rate movements. Remember, at a fixed rate you stand to lose if interest rates go up to a point where money market instruments offer higher returns than your yield. Of course the opposite is true if interest rates go down.

This is why the rate offered is varied by the expectation of the bank (or National Treasury in the case of the Retail Bonds) on where interest rates are going. Considering that we are at interest rates last seen almost four decades ago, many analysts see the interest rate increasing in the medium term and hence part of why an attractive rate is offered for a longer duration.

Another aspect to consider is that of "risk".

In the fixed rate environment, this relates to the borrowers ability to honour its repayment obligations. The mainstream banks in South Africa have very robust credit ratings (in line with the SA Government) and the likelihood of default is negligible. As a general rule, the lower the credit rating, the higher the yield on a bond/deposit of the same duration.

The question of costs is tricky as both of these instruments offer net amounts and all costs can never be fully calculated or compared.

Of course, before committing to any investment or savings structure that requires time, it is important that you have sufficient liquidity by means of an emergency fund. By and large, dipping into one of these will result in penalties or capital loss.

The Financial Planning Institute of Southern Africa (FPI) is the leading independent professional body for financial planners in South Africa. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a CERTIFIED FINANCIAL PLANNER® professional who, after an analysis of an individuals’ personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice

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