your return from the same investment at the same interest rate could be different because of the way banks calculate and credit interest
Point something of a per cent sounds very little. But those little 0.1% or 0.2% differences on the margin in interest rates can make a big difference to your net worth. So too can the way the bank calculates and credits interest to your account.
Investors often choose the term they want to lock their money away for first and then go shopping to find the best rate.
If they simply look at their own bank they could be making a mistake. At the time of writing, the major banks in New Zealand were offering between 1.80% and 5.55% for 12 month term deposits, with many in the 4s. That’s a very wide spread indeed.
A $100,000 retirement nest egg invested at 1.8% would return $113,399 compounded over 10 years and 30% marginal tax deductions. At 5.5% it would grow to $145,903.
Making a choice between rates sometimes involves a fraction of a per cent. Should you or shouldn’t you invest your lump sum for six months, one year or even five years?
It’s true that 0.2% between a six month or one year rate isn’t much. But over time it can add up significantly.
A $100,000 nest egg invested for 10 years at 5.35% returns a total of $144,435 after tax. At 5.55% the return is $146,396.
The difference is even greater if interest is credited daily, not annually. RaboDirect’s Mike Heath explained the need to look beyond the advertised interest rate, where he pointed out that your return from the same investment at the same interest rate could be different because of the way banks calculate and credit interest.
Everyone’s circumstance is different. You might only be four weeks from financial disaster if you lose your job and need your emergency fund on call. Short term rates do give you flexibility, but it comes at a cost.
Over five years you could be getting nearly one per cent more than you would investing for one year.
Some people, especially retired folk, need to budget precisely and the guarantee of 6.45% for the next five years is very welcome indeed.
Hopefully no-one in their right mind would have $100,000 invested in a low interest call account, which can offer 1% or less . But what happens to your term deposit when it matures? Do you get dumped in a low interest investment automatically or does it roll over onto the current rate? A few months here and there on 1% can make a huge dent in your long term savings.
Likewise if the bank credits your cheque or current account when your term deposit matures you could be losing interest hand over fist for the time it takes you to get your act together and take out another term deposit?