Watch out for lock-ins when rate rises loom

A fixed-term lock-in for perhaps five years is generally not advisable when a rise in interest rates is expected.

A fixed-term lock-in for perhaps five years is generally not advisable when a rise in interest rates is expected.

Investors can’t time the market, but some issues in the financial service sector are predictable and one of those issues concerns the marketing of fixed-interest securities.

Consumers should exercise caution when they see fixed deposit and similar products are being strongly advertised, says Lara Warburton, managing director of Imara Asset Management South Africa, an advisory and fund management firm with a growing retail client-base.

“The reason is that a fixed-term lock-in for perhaps five years is generally not advisable when a rise in interest rates is expected,” says Warburton.

“The benefits of this type of fixed-interest product are often communicated strongly at a stage in the interest rate cycle when the professionals expect rates to move higher.”

She acknowledges that after a prolonged period of low interest rates, a guaranteed rate that’s well above the recent ‘floor’ may look tempting; especially for older investors who are risk averse.

“At the moment,” says Warburton, “a guaranteed rate of perhaps 7% over five years may look attractive, but 12 or 18 months down the line that rate may look rather modest, in the event of one or two rate rises by the authorities.

“Product providers take a long view. Consumers are entitled to do the same.”

In the past, consumers had few options when looking for solid income at low risk. Fixed deposits for a fixed term became the norm for many, says Warburton. Today there is greater choice.

She explains: “In March, government introduced tax-free investments (TFIs) to encourage greater saving.

“With TFIs, individuals can save up to R30 000 a year, knowing that growth within the investment is tax free. What’s more, there is no capital gains tax.

“Lifetime contributions are capped at R500 000, though build-up over time may take the capital sum into the millions if you start early. There are no lock-ins and switching between products is possible. You earn competitive rates of interest or growth on the capital without having to commit the money for years on end.”

The flexibility of the product options and its advantages deserve careful consideration by almost all categories of retail investor.

“Consumers should ask about these newly introduced products at their next meeting with their financial advisors,” adds Warburton. “In particular, they should enquire about the advantages and disadvantages of the various TFI options to ensure they select the best one to grow capital for retirement.”

“Special attention should be given to the downside associated with lock-ins when the interest rate cycle seems to indicate higher rates are on the way.”



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