Rate of change: considering investment options

A year ago, when deliberating the interest rates, pundits expected a steady and quick rise. In reality, the climb proved to be slow.

FedGroup CFO Scott Field's investment approach begins with an evaluation of some hard numbers.

"I always like to paint a few scenarios based on our five-year participation bond investment, and use research, the comments of trusted economists, and historical trends as guidelines.

"The mistake often made by investors who are gauging new investment products, is to simply compare the variable rate against the fixed rate, which at first glance may seem highly appealing. The key is to consider the full investment term," says Field.

Scenario 1 - a consistent, gradual hike

"One should bear Gill Marcus' comments from earlier this year in mind, when she reminded the public that the mandate of the monetary policy committee was not to grow the economy. This came on the heels of a 25 basis point repro rate hike. A not unlikely scenario is painted below, which outlines steady rate hikes until May 2017, and draws a comparison between fixed and variable rate investment gains," says Field.

Fig A represents the current variable investment rate of 6.75%, the corresponding fixed interest rate of 8.25%. "x" represents FNB's household and property strategist, John Loos', forecast, while "y" shows the predicted interest rate hikes of respected economist Mike Sch"ussler. Field pitches his prediction mid-way between the two, with continued staged hikes until plateauing in May 2017 at just under 10%.

Field has exhibited caution by opting to plateau the rate in May 2017.

"At the moment, we are seeing rates climbing, though more slowly than analysts were expecting. Reserve Bank governor, Gill Marcus, is performing an extremely difficult and delicate balancing act in terms of limiting inflation while not discouraging growth," he says.

However, even while taking a very conservative view of hikes, with the steady cycle of increases, Fig A clearly illustrates that over a five-year term, investors are far better off choosing a variable interest rate.

Scenario 2 - mirroring Marcus' actions from January-July 2014

Fig B mirrors a similar movement of the repro rate over the past seven months, up until July 2016. Again, the current and fixed interest rates are represented. Here we see steeper hikes than in the first scenario, and while it garners less support as a prospective model from industry experts, it is certainly not unfeasible.

Once again, choosing a variable interest rate is the obvious choice when gains are compared.

Conclusion

"It might seem counter-intuitive to go with a variable rate, as at the outset of the investment, it will be lower than the fixed rate. However, over the full term of the investment, it will likely yield better results. Even with a conservative outlook, a variable rate is the way to go.

"In addition, locking myself into a fixed rate now would be detrimental, because the relatively small amount of growth likely to accrue would be coming off a very low base.

"And there are unlikely to be wild fluctuations in the rate. So, a variable rate will give me the benefit of the rate increases that do happen without me having to incur any significant risk. Having done the numbers, I can make this decision with confidence."