Consumers still being misled over interest rates
WORDS ON WEALTH
I return to a pet peeve: the deceptive advertising of interest rates on fixed-term investments. It has been an ongoing problem with the banks, and now an insurer has latched on to the practice.
The practice is to translate the interest you receive at the end of an investment term into an annual simple rate that doesn’t take compounding into account. Over five years, say, the accrued interest is simply divided by five, giving you a higher percentage than your actual annual rate if you were to withdraw the interest each year. This higher rate is used in marketing material to woo customers, who, in many cases I fear, do not even know the difference between simple and compound interest.
Some weeks ago, I received an email from a reader, Frans, who does know the difference. He wanted to know why he had received much less interest than he expected from a five-year Nedbank fixed deposit.
He said he invested R400 000 at a rate of 10.16% a year.
“I was paid interest of R202 000 and think it should have been closer to R246 000 I feel that the interest should have been added to the capital each year (compounded). I would appreciate your calculation of what should have been paid to me after the five years.”
I calculated thus:
- 10.16% interest compounded annually over five years: R248 902
- 10.16% simple interest over the five years (R40 640 x 5): R203 200
This meant that Frans received even less than my calculated simple rate.
What gives? I asked Nedbank.
Sisa Cikido, head of retail investments at Nedbank, replied: “The investment that you refer to is our Green Optimum Deposit product. The product offers clients the option to select investment terms between 18 and 60 months, and a choice of how frequently they want interest paid out (monthly, quarterly, half-yearly, annually, or at expiry). In this scenario, we should look at the 60-month investment term, with interest paid on expiry.”
Cikido said that on July 14, 2014, when Frans deposited his R400 000, the following rates were applicable on the product:
- Interest paid out monthly: 8.25%
- Interest paid out annually: 8.56%
- Interest paid out on maturity: 10.16%
He continued: “Interest on this product does not compound during the investment term. This means that interest is calculated on the original investment amount and interest is not added to the capital during the investment term. To compensate for this fact, we offer clients a higher, effective interest rate that equals the comparative nominal interest rate.
“A client who invests funds in an investment that pays 8.25% with interest compounding monthly over 60 months (in a product that allows this) would thus get the same yield than a client who invests at a rate of 10.16% with no compounding over the same investment term.”
Cikido did the calculation, and it came to R203 311 – very similar to my simple-rate calculation (which still doesn’t explain why Frans received more than a grand less than that).
He said: “The fact that interest on the product does not compound during the investment term is detailed in the product disclosure that is made available to clients before they select to open an investment.”
If the fact that it was a simple rate was disclosed to Frans, why did he expect more come the end of five years? Is it Frans’s fault that he didn’t read the small print of the contract, or is it the bank’s fault for not directly pointing it out to him?
I’d love to know how many other consumers invested under these false expectations.
Nedbank, I am happy to say, has reverted to giving nominal and effective annual compounded rates on its savings and investment products.
Cikido says: “To ensure that clients are able to draw comparisons between yields on our products, we decided to ensure that we would always publish rates on both a nominal (for interest paid out monthly), as well as a term-effective basis.”
But other banks and now even an insurer are continuing with this practice. African Bank is advertising 13.33% on maturity on a five-year fixed deposit where the actual compounded annual rate is 10.75% (still extremely good, considering inflation is down to 4.3%).
What’s more concerning is an email I received from OUTvest, OUTsurance’s investment arm, which adds the issue of tax to the mix: “You might have heard about it by now, but in case you haven’t we would like to introduce you to Fixed OUTcome. A five-year endowment that offers you a fixed interest rate and a fixed maturity value that beats inflation, even after tax. To beat our after-tax rate you might need to find a return of 15.27% per annum before tax.” (The figure has subsequently been adjusted to 15.2%).
Endowment policies are fixed-term investment products offered by life insurers. They are taxed internally on interest at 30%, so they only make sense for an investor whose marginal income tax rate is greater than 30% and who has used up his or her exemption on interest of R23 800 a year (R34 500 a year for people aged 65 and over).
The figure of 15.2% represents the interest rate that someone on the highest tax bracket of 45%, who has used up his or her exemption, would have to earn to equal the return of the OUTvest product.
But wait! That rate is a simple rate, as OUTvest explains in small print on its website. The annual compounded rate of return, less the 30% taken by the taxman, is just 6.6%.
Whether that after-tax rate is attractive will depend on your circumstances, but it certainly doesn’t blow my socks off.
In my view, to bandy around a figure of more than 15%, when the internal pre-tax rate is just under 10% and the actual return you get is 6.6%, is not exactly being straightforward and open with you, the consumer.
What the regulator says
Caroline da Silva, the executive of regulatory policy at the Financial Sector Conduct Authority (FSCA), had the following to say when Personal Finance asked her about the advertising of interest rates on fixed-term deposits and endowment policies: “The FSCA recognises that there is not a uniform approach across the financial sector when advertising interest rates that a customer could earn in respect of a financial product. Customers are also not able to easily compare products unless they are able to calculate and convert the different interest rates used.
“To address some aspects of the concern, the conduct standard the FSCA has drafted for banks does encompass requirements with regards to interest rate disclosure and advertising, amongst other requirements, that we would like to see in place from a conduct authority perspective.
“The extent of the proposed rule is that where a bank advertises the interest payable in respect of a deposit product, the bank must, in addition to any other interest rate being disclosed, also disclose the effective annual interest rate of the financial product. The aim of the requirement is to enable comparability of products and to ensure that customers are not misled.
“The standard was published in April this year for public comment, and we are currently assessing the comments received. The standard and all supporting documents are still available on our website, however, the comment period has already closed.
“The aim is to have the standard finally published and in force by early 2020 although some requirements may have different effective dates.
“Over and above this, we are looking to harmonise all sectoral laws so that we can have consistency with regards to advertising and disclosure.”