How best to save as bank deposits regain relevance

The Bank of Israel’s decision on Monday to hike the interest rate by 0.5% to 3.25% immediately translates into a rise on mortgage repayments. But on the other hand, the higher interest rate offers solid investment options, in which households can put their savings.

After more than a decade in which the zero interest offered by banks on deposits made it an almost irrelevant option, products linked to the central bank interest rate, which rise or fall according to the Bank of Israel interest rate, are suddenly back in fashion. These options are attracting more and more customers, especially at a time when the capital markets are volatile.

Israel’s banks have raised the average interest rate paid on deposits for one year from a fixed rate from only 0.27% in April, before the first interest rate hike, to 3% in October, and have managed to raise more than NIS 103 billion from the public in just the last two months. For comparison, the total of new deposits in March and April was only about NIS 45 billion.

At the same time, financial mutual funds, which by the nature of their activity are more similar to bank deposits than to managed mutual funds, or those that follow certain indexes or sectors (exchange traded funds), tripled the volume of assets they manage – from NIS 16.5 billion to more than NIS 41 billion.

To these two products can be added another type of mutual funds, those specializing in government bonds. Although they are more volatile than bank deposits or financial funds, they may also generate a higher return – and will not suffer automatic decreases in return as the Bank of Israel’s interest rate falls.

According to the forecast of the Bank of Israel research division and analysts’ forecasts, the interest rate will continue rising to around 3.5%-3.75%. However, next summer it is expected to start falling, and if that is the case, interest rates on fixed deposits will also start falling.

A major advantage of these last two products, investing through financial mutual funds or in bonds, is their liquidity compared with bank deposits. With mutual funds, you can give a sell order when the value is calculated according to the value of the bond, on the given trading day, (which can reflect a high or low price in relation to the price at which the bond was bought). The return, of course, will not be the same as the one promised for redemption at the end of the period, but it will not include a penalty as the banks charge when closing the deposit before the agreed date.

Who is offering the best interest rate?

As with loans and mortgages, so with bank deposits customers can choose different tracks in which they want to deposit their money. The banks offer tracks with a fixed interest rate which, despite its name, is calculated according to the interest rate of the Bank of Israel, or a track with a variable interest rate – the prime track (the Bank of Israel interest rate, plus 1.5% and less the financial margin that the bank chooses to give to its customers).

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Since the Bank of Israel interest rate began to rise in April, the banks have raised the fixed interest rate. On Monday, immediately after Bank of Israel announcement of another interest rate hike, Israel Discount Bank (TASE: DSCT) announced that it was once again raising the interest rate on deposits for a period of one year at a fixed rate to 3.75%.

At the same time, the bank is offering interest on a one-year deposit at a variable rate, which will be the same as the Bank of Israel rate: 3.25% and will be updated according to the Bank of Israel’s future interest rate changes. The bank offering the highest interest rate in the variable interest rate track is One Zero (Israel’s recently launched digital bank), which even before the last interest rate hike was offering an annual interest rate of 3.4%, and this is now expected to rise to 3.9%.

However, this is a deposit for three months to a year, and those who need more immediate access to the money will receive much lower rates on daily or monthly deposits. The rate for a bank deposit closed for up to three months, where most of the public funds are deposited, is currently only 1.05%.

In financial funds, monthly returns hover around the Bank of Israel rate, as with deposits, but higher by about 0.1%-0.2%. This is because they have an average life of up to 90 days, and can combine slightly longer makams (government bonds), as well as buy very short bonds from banks, which add additional fractions of a percentage.

Dollar funds have raised hundreds of millions this year

Dollar financial funds offer even higher returns, around 4.5%, because the interest rate in the US is higher – and they have already raised hundreds of millions of dollars from Israeli customers this year.

In a third savings product, mutual funds that invest in government bonds, a customer who closes money for three years can receive a return of 3.2%, very similar to the current interest rate. However, the advantage of this product over the other two interest-linked products is that this interest rate is guaranteed, even if the Bank of Israel decides in a few months to start cutting the interest rate. Another option is a trust fund that invests in government bonds linked to an index that protects the client from the rise in inflation, and these offer a three-year interest rate return equal to the Consumer Price Index (CPI) + 0.5%. This is a return that can protect savings because of the erosion of money in an inflationary environment.

Tel Aviv Stock Exchange EVP head of trading, derivative and indexes Yaniv Pagot says that investing in these funds has an additional advantage. “The investor can benefit beyond the returns that the bonds pay also by profiting on the capital. If the market thinks that the interest rate will fall from 3.25% today to 2%, the investor will still be able to earn annual interest of 3% plus further capital returns of an additional 3%-4% – and even reach a return of 7%.”

How much tax must be paid on profits?

A significant issue that affects these decisions on where to save money is the question of taxation, when the investment matures. While bank deposits are subject to a 15% tax on the nominal profit, both financial funds and funds that invest in bonds require payment of 25% tax, but only after nominal profit is adjusted to inflation.

Average inflation expectations in Israel over the next 12 months are estimated at 3%, so if inflation in the coming year does meet these forecasts, the investor will be liable to tax only for excess profit of over 3%. Therefore, investing in government bonds through the funds is preferable in terms of tax over direct investment in bonds, which require payment of a 15% tax on the nominal profit.

Published by Globes, Israel business news – en.globes.co.il – on November 24, 2022.

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