Fixed-income investments explained

Feel free to reach out to PSG Wealth adviser Jeandré Eygelaar directly.

In this article, I would like to highlight some important considerations regarding interest-bearing instruments.

In short, interest can be described as the cost of borrowed money. This is money paid by financial institutions to reward their clients for depositing money or investing with them.

There are three important questions to ask yourself when considering an investment in fixed-interest instruments:

1.     Does the investment offer liquidity?

Financial institutions often offer higher interest rates when the money is invested for a fixed term – the longer the term, the higher the interest rate offered. In most cases, you won’t be able to access the money until the term has expired – at least, not without being ‘penalised’.

2.     What is the risk?

It is important to check the credit rating of the institution you choose to deposit your money with. Effectively, you borrow your money to that institution and earn interest in return. You may be earning high interest because the institution has a higher risk profile.

3.     How are the proceeds taxed?

Although some exemptions apply, generally, interest is fully taxable and will be included in your taxable income, whether you choose to have income paid out or not. For individuals under 65 years of age, the first R23 800 interest earned per annum is exempted from tax. For individuals aged 65 and older this exemption is R34 500 per annum.

I have compiled the table below to illustrate the expected after-tax return on a R1 million investment, assuming that your interest exemption of R23 800 p.a. has already been utilised elsewhere.

If you are invested in a fixed deposit product, you won’t be able to dip into this investment to pay the tax. Access to these investments is usually not allowed without being penalised.

Furthermore, it’s important to compare apples with apples. Nominal interest is the interest you will earn if the interest is paid out monthly. Effective interest is the total interest earned over the investment term, assuming that the interest is capitalised (compound interest). The nominal rate is usually lower than the effective rate.

Alternative options for investing in interest-bearing instruments

• Unit trusts – Although fixed (guaranteed) interest rates advertised by banks and other financial institutions may look attractive, investing in interest-bearing funds with exposure to various interest-bearing instruments and institutions may often be a better alternative. In addition, unit trusts offer liquidity, as withdrawals can be made if necessary.
• Guaranteed investment plans – These products offer tax benefits (for individuals in high tax brackets) and beneficiaries may be noted, but liquidity is limited.

It is important to do holistic planning and to take all factors into consideration before any investment decision is made.

You are welcome to contact me to discuss your unique circumstances and find the appropriate solutions.