Make sure you read the fine print when looking for a bank at which to invest your money.
Some banks quote the effective interest rate rather than the nominal rate. The effective rate is based on multiple compounding periods, while the nominal rate is based on a single compounding period. For example, a 12-month fixed deposit can earn annual, bi-annual, quarterly or monthly compounding interest. The nominal rate is when interest compounds only once, or in this case annually.
When you invest money, the bank promotes effective rates (which include compound interest), but when you borrow money, they punt the lower nominal rates.
When making comparisons, it is simplest to compare the nominal rates of all banks. When looking at advertisements, you should compare apples with apples.
This week, Nedbank ran a newspaper advertisement offering an effective 13.02 percent on a 12-month fixed deposit, when in fact the average effective rate is 11.02 percent.
Personal Finance reader Avishkar Dukhi of Durban found the advert misleading. He has been shopping around for a place to invest some surplus capital and regarded the rate as highly competitive until he phoned the bank's call centre.
"The person at the call centre said that the effective rate was only for the last quarter of the fixed term (being for 12 months) with a weighted average rate of 11.02 percent for the full term," Dukhi says.
Darrel Orsmond, a director of transaction products at Standard Bank, says banks' adverts about interest rates should be clear.
Colin Donian, the head of wealth creation and preservation at Nedbank, denies that the bank's advert is misleading. The 13.02 percent advertised for a 12-month fixed deposit has fine-print footnote explaining that 13.02 percent "is the effective annual rate based on a nominal top-tier rate of 12.50 percent".
He says it is an ordinary fixed-deposit product which is structured across four quarters so that you get a different interest rate each quarter. In the first quarter, you get a nominal interest rate of 9.25 percent, in the second quarter 9.75 percent, in the third quarter 10.50 percent and in the fourth quarter 12.5 percent.
You would earn R10 500 interest on a R100 000 if you did not add your interest to your capital every month, and R11 020 interest if you did.
The Advertising Standards Authority did not uphold a complaint about a similar Nedbank advertisement last year, Donian says.
He says banks have no intention to mislead the public and Standard Bank had advertised its money market rate in a similar way this week.
Nominal interest
Nominal rate or simple interest is based on the interest rate for a year. If you invest R100 and get 10 percent a year, you will receive R10 in interest for that year.
Effective interest rate
The effective interest rate includes the effect of compound interest. Compound interest is when you earn interest on top of interest by re-investing the interest.
For example, if you invest R100 at 10 percent a year and interest is compounded monthly, an amount of R100 would become R100.83 after one month (R100 capital plus interest of R100 x 10% x 1/12).
At the end of the second month, it would be R101.67 (new capital of R100.83 plus interest of R100.83 x 10% x 1/12) and so on. After 12 months, it comes to R110.47. This means you would have earned 10.47 per cent in interest and not 10 percent on your R100 investment after a year.