Feb 23 Interesting Deposits

A man bought a donkey from a farmer for £100 and the farmer agreed to deliver the donkey the next day. The next day he drove up and said, “Sorry, but I have some bad news. The donkey’s died”. The man replied, “Well then, just give me my money back”. The farmer said, “I can’t do that. I’ve already spent it”.

The man said, “OK then, just bring me the dead donkey”. The farmer asked, “What are you going to do with him?”. The man said, “I’m going to raffle him off”. The farmer said, “You can’t raffle a dead donkey!” The man said, “Sure I can. Watch me ! I just won’t tell anybody he’s dead”.

A month later, the farmer met up with the man and asked, “What happened with that dead donkey?”. The man said, “I raffled him off. I sold 500 tickets at £2 a piece and made a profit of £898”. The farmer said, “Didn’t anyone complain?”. The man said, “Just the guy who won. So I gave him his £2 back”.

-The man now works for a UK bank that shall remain nameless.

Over the last few issues of the Bodrum Bulletin we’ve looked at some of the alternatives to bank deposit accounts. In the past most of us have relied on these to generate income from interest but 2009 unfortunately saw record falls in rates around the world. Now the Turkish Central Bank are oscillating between maintaining current low rates and small rate rises that could start as early as the 2nd quarter of this year. Virtually every country has the same dilemma as to when to start raising rates but once Europe and the USA start, Turkey will have no choice but to follow suit even without the Turkish inflation threat.

So is it best to just put everything into one long term deposit or are there ways to maximise interest ? The best strategy will as usual depend on future expectations. If interest rates are expected to fall, then generally funds should be deposited for as long as possible in order to get the longest period of the highest rate. However, that is definitely not the situation in early 2010. Rates are going to rise, the only question is how far and how fast.

First though, let’s look at compound interest. As interest is usually only paid when the deposit matures, if you don’t have an immediate need for the interest then compounding it can make a useful difference. As an example, say your bank is offering 8% interest and you have 10,000 TL to invest. If you simply put it all on deposit for a year, you will receive 800 TL (before tax) one year later. However, if you were to put it on deposit for only one month with interest added to the account automatically at the end of the month before rolling it over for another month, at the end of the year you would have 830 TL in interest.

OK so that might not seem a great deal. But now consider if rates were to go up say 1% every quarter. Now you would have 992 TL interest by year end. If rates were to return to say 12% (which is quite possible), then the annual deposit returns 1200 TL whereas the monthly compound would give 1268 TL.

If you are likely to need to convert lira back to sterling, then your deposit account strategy becomes even more important. As we have seen in an earlier article, foreign exchange movements can very quickly wipe out all interest earned on deposit and even leave you with less money than you started with. In order to take advantage of the best rates (which can often change 2-3% in the course of a single day), you need to build in as much flexibility as possible into your deposits. That means having as many maturity dates as possible so you are not forced to close an account early with loss of all interest to date. Alternatively, also make use of mutual funds that only need one or two days notice to convert back to cash.

So, how are our various investments doing so far this year ? As the table above shows, Type A mutual funds (that include some Turkish stocks) are doing best. However, the recent political tensions in Turkey have knocked the Turkish stocks as all stock markets hate uncertainty above all else. The UK share portfolios have been negatively affected by the Greece/Euro crisis and the continued debate of future interest rate hikes. Bear in mind that portfolio B has twice as many different shares and therefore a greater proportion is needed to cover transaction fees. Top performing share in the higher risk Portfolio C, Punch Taverns, has risen 19% so far this year whereas the worst, PVCS, has lost 13%. In comparison, none of the shares in the more conservative A and B portfolios have changed by more than 7%.

IMPORTANT NOTE: Shares and other investments have been selected to illustrate different investment strategies. They should not viewed as recommendations to purchase.