Options in the valley of low interest rates

Pretoria East October Newsletter 2021

South African investors who rely on low-risk, interest-bearing investments have found themselves struggling in recent years.

In 2020, the South African Reserve Bank reduced interest rates by 3%, bringing them down to a record low of 3.50%. This was in order to support the economy in response to the Covid-19 pandemic.

Source: tradingeconomics.com

Prior to this, South African investors, and pensioners, in particular, had been spoiled for quite some time by abnormally high interest rates. Not only were South African interest rates high compared to those in the rest of the world, but even ordinary money market returns had been beating inflation over the preceding five years. The PSG Money Market Account returned 6.33% over five years compared to the inflation rate of 4.40% per annum.

The dangers of chasing returns

We moved quite rapidly into a ‘valley’ of low interest rates. When this happens, investors are forced to start looking for alternative options and this, in turn, creates other risks. Firstly, investors confuse their short-term goals with their long-term goals. Secondly, find themselves in a mindset of pursuing higher returns without taking the additional risks into account. The sharp recovery in the stock market over the past year could rapidly influence investor appetite for additional risk. Thirdly, this is an environment that creates an ideal breeding ground in which investors can be misled in their search for investment products that guarantee higher returns. South Africa has seen far too many examples of pensioners and savers having to tighten their belts due to extreme over-promising by, for example, Sharemax and, more recently, Ecsponent. It seems inevitable that blind spots such as these will re-appear in the future.

Separate short-term goals from long-term goals

It is extremely important to set clear goals for your investment capital in order for it to be able to meet your diverse needs. Short-term needs usually include provision for income, an emergency fund, and specific expenses that will arise for vacations, vehicles, and the purchasing of property.

In this segment, the options are limited to ordinary savings accounts or money market investments that should see you earning between 3.50% and 4.50%. Low rates such as these might be disheartening, but this is the price you pay for the security and liquidity of your capital. The goal here is not to chase returns, but rather to ensure access to your capital.

Once you move further up the yield curve, you can start looking at fixed-term options or unit trust funds, even though these do involve a degree of capital risk in the short term.

An example of a fixed-term investment is that offered by Capitec Bank where you can lock in a return of 8.80% over a period of five years. SA Retail Government Bonds, meanwhile, now offer a return of 9.00% over five years. Pensioners aged 65 and older can achieve these returns almost tax-free by making use of their annual R34 500 interest exemption on a maximum amount of R400 000. Depending on your personal tax rate, you can invest even more in it without any effect on your tax liability. However, if you already fall into a high tax category, this option begins to look less attractive.

Of course, these returns do not come without risks and this must be weighed against each investor's individual needs and circumstances.

As regards unit trusts, there are funds available made up of cash along with corporate and government bonds. An example of this is the PSG Wealth Income Fund of Funds, which is exposed to a wide range of asset managers who spread the risks in this category. This fund's yield over five years and longer has been a constant 7.6% per annum before deduction of advisory and administrative costs.

Summary

There is a fine line between looking at alternative investments to achieve better returns and sticking your neck out to chase higher returns irresponsibly. The options in the interest-bearing environment are very limited with the ceiling just above your head. However, as soon as you go after better returns, you need to give up the availability and guarantee of your capital. You should guard against allowing the low interest rate environment to push you into taking risks that are not in line with your needs and circumstances.

Should the provision you have made for your short-term needs seem excessive, please feel free to contact your PSG Pretoria East Wealth Adviser to ask about alternative options. A well-considered investment portfolio, composed of cash, bonds and real estate, along with local as well as foreign equities, should yield better returns for you over the long term. This possibility comes courtesy of the stock component, which has the potential to skyrocket.