The best ways to stash your cash
Retail bonds, fixed deposits or preference shares?
When National Treasury launched RSA Retail Bonds in May 2004, they were touted as a no-cost, safe, secure and risk-free investment that would give ordinary South Africans the chance to earn bond-market returns. At the time, Treasury said that "returns in the government bond market have outperformed the rest of the market for the past ten years. With the addition of the RSA Retail Bond to National Treasury’s already diversified portfolio of financial instruments on offer, ordinary citizens now have the opportunity to benefit from similar returns".
Government’s primary objectives for issuing RSA Retail Bonds were to diversify the financial instruments on offer to the market, to target a different source of funding for government, and to create public awareness of the importance of saving.
These sentiments still hold true nearly 15 years later – but what is the best option when comparing retail bonds (also known as retail savings bonds), a traditional fixed deposit, and an investment in prime-linked preference shares issued by banks and listed on the JSE?
Treasury designed retail bonds to encourage saving.
One of the problems with retail bonds is that an investor can only choose between three investment terms (two, three or five years), while banks offer fixed deposits from a few months to a few years and anything in between. A fixed deposit of seven, nine or 19 months is, for example, available at the bank down the street.
However, investors are able to sell retail bonds back to Treasury any time after the first 12 months, for a penalty equal to one interest payment (interest is paid every six months). For people older than 60, who can elect to receive monthly interest, the penalty will be equal to only one month of interest.
A second disadvantage of retail bonds is that it’s generally easier to make a fixed deposit at your current bank than it is to buy a retail bond. Most South Africans already have bank accounts and have supplied the necessary Fica documents, and can thus make a fixed deposit within minutes.
A deposit at a different bank requires a repeat of the whole
Fica process, in which case investors may as well look at retail bonds. Investors can purchase the RSA SavingS Bonds from any post office. Alternatively, investors can purchase bonds directly from national treasury by visiting their website.
An advantage of retail bonds is that an investor can nominate someone as a beneficiary of the bond and interest receivable in the case of the investor's death. The bond will immediately transfer to the beneficiary and will not be tied up in the deceased's estate, although the value of the investment will be included in the estate for purposes of estate duty.
Although important, these issues take a back seat to the main consideration – where will one get the best return? As when buying a new car, a clever optional accessory can change the performance of each alternative significantly.
Regular changes in the fixed interest-bearing market means that, to get the best out of any interest-bearing investment, a bit of planning is required.
Banks currently offer at least the same, and sometimes better, returns on fixed deposits than the rates on retail bonds. The interest rate on RSA Retail Bonds is currently 7.75%, 8% and 8.5% per annum on the two-, three- and five-year bonds respectively. In comparison, Nedbank offers savings bonds over similar periods with higher interest rates; 8% per annum for a two-year investment (with interest paid every six months), 8.25% on a three-year bond and 8.75% over five years.
However, this isn’t always the case in fluctuating interest rate markets.
An interesting feature of retail bonds is that investors can ‘restart’ (or reset) their investments when interest rates change – and this puts a different perspective on the situation. Gordon Fordred, founding member of advisory service Bond Club, says this feature makes retail savings bonds very attractive. “The option to restart the investment should interest rates rise removes the risk usually associated with fixed-rate investments,” he says. “In our view, these bonds are the best interest-rate investment available in SA.”
The restart option gives investors the freedom to revisit their investment decision whenever interest rates increase. They can restart the bond at any time after 12 months at the higher interest rate and select a new investment period of two, three or five years.
The spread offered by the five-year retail savings bond vs five-year government bond rate traded on JSE
Source: Bond Club
If interest rates decline, the higher rate still applies. The result of the option to restart is that investors get the best of both worlds: a fixed rate should rates decline, and the ability to restart at the higher rate should they rise.
Treasury announces changes to interest rates on retail bonds at the beginning of every month (based on the rates of long-term government bonds in the capital market on the last trading day of the previous month).
Bond Club has designed an online tool that helps investors to manage their bonds and increase the yield. This tool allows users to create a portfolio and list their bond purchases. The application then tracks the performance of the bonds, uploads changes in interest rates, advises when interest payments are due, and tracks annual income to investors.
Desktop image taken from BondClub.co.za
Source: Bond Club
A useful feature is that it tracks the trend in interest rates on the capital market and advises investors when to restart their bonds to benefit from higher rates. “Interest rates on the capital market seem to trend upwards at the moment and we expect Treasury to announce a significant increase at the beginning of July,” says Fordred.
Fordred recently demonstrated the tool to Treasury as he believes the restart option isn’t marketed as well as it should be. “The RSA Retail Bond is a one-of-a-kind product in the world,” he says. “It offers high rates to everybody whether you have R1 000 or R5 million to invest.” He believes it isn’t marketed actively enough because it offers no commission or fee income to financial planners. “The total return ends up in the investor's pocket.”
Investors who choose bank deposits have the benefit of a bigger range of ready-made investment options, especially if they want a term shorter than two years.
Rates are slightly lower, but remain competitive. A 12-month fixed deposit of at least R10 000 will earn 7.1% at Absa, 7.45% at Standard Bank, and 7.76% at Investec. And banks usually charge monthly fees.
Investors can use the wider range of options at banks to increase their yield by trying to jump to the next category. All banks use a similar type of sliding scale over different terms and different amounts; returns increase as the deposit amount and term of investment increase.
For instance, Capitec offers a nominal rate of 7% per annum for an investment of R25 000 over a period of six months. An investor would be better off considering a seven-month period, which offers a higher rate of 7.2% per annum. Increasing the deposit slightly, to just above R25 000, will also earn a slightly higher interest rate. Earning 7.25% (nominal per annum) on R25 100 over seven months is much better than 7% on R25 000 over six months.
Retail savings bond rates 2017-2018
Source: Bond Club
At levels above R300 000 tax may become an issue.
There is no difference in the liability for tax between retail bonds and fixed deposits. Sars sees interest as normal income and taxes it at the same rate as a taxpayer's other income, except that the first R23 800 of interest received is exempt from tax.
At the current interest rates, tax only becomes an issue when your interest-bearing investment exceeds R300 000. At this level it is worth looking towards the JSE and the banks' prime-linked preference shares, particularly if the investor is in a high tax bracket as dividend withholding tax is only 20%.
These prime-linked preference shares were popular with investors and banks alike when they were introduced in the late 1990s. However, a change in legislation (which excluded preference shares from banks' Tier 1 capital) made them less attractive to issuing banks, and the subsequent change in tax status made them less desirable among investors.
At one stage, bank preference shares offered tax-free yields as high as 12%, but current yields are around 10% to 10.4% per annum. All bank preference shares pay interest every six months. Unfortunately, transaction costs are quite high because investors need to buy the shares through a stockbroker. Stockbrokers charge about 0.5% in commission to buy R300 000 worth of shares, and another 0.5% to sell them again. A levy of 0.25% is charged on purchases. Monthly charges to maintain a share account fluctuate between R50 to R100.
To buy, hold and sell R300 000 worth of preference shares will cost an investor nearly R5 000 in fees, reducing the
pre-tax yield from 10.2% to 8.5% over one year and 9.2%
over two years
(because the high transaction cost is split over two years).
It’s important to note that dividend withholding tax kicks in from the first rand, reducing the yield even further. These preference shares are thus only suitable for investors in high tax brackets who want to invest large amounts. A trick to increasing the yield is to buy preference shares just before a dividend is declared, and to hang on to them for 13 months. The simple argument is that three bi-annual dividend cheques are better than two.
Every investor has their own needs and might prefer a specific product. Whatever it is, even a few rands tucked away somewhere will let you sleep better.■
Adriaan Kruger is a former stockbroker and writes on the financial markets.