Should I save emergency funds in a fixed deposit or unit trust?

Dear reader,

Thank you for your question.

There are many things that happen that we never seem to plan for, whether it be car complications, geyser bursts, or job losses. As much as we would like to control the likelihood of these things happening, they are inevitable. A well-thought-out financial plan should make provision for the inevitable and should aid in alleviating the pressure that is placed on budgets when these things happen. Having an emergency fund should be one of the first things you consider when building your investment portfolio.

Fixed deposit

A fixed deposit is a financial instrument offered by banks and non-banking financial companies (NBFCs) to their customers to help them achieve their money-saving goals. When investing in a fixed deposit, you can invest large sums of money at a predetermined rate of interest for a fixed period. At the end of the period, you should receive a lump sum together with interest. Various interest rates are offered by banks and NBFCs.

An advantage of investing in a fixed deposit is that the rate of interest remains the same, irrespective of any changes that happen because of market fluctuations.

However, if ever there’s a life-or-death situation and you need to withdraw funds before your period has come to an end, you will be able to do so – but you will be liable to pay a penalty.

There are tax implications when investing in a fixed deposit, but you will only be taxed on the interest earned in any one tax year exceeding R23 800. This tax exemption increases to R34 500 per annum if you are 65 or older.

Unit trust

A unit trust is a financial instrument that pools money from many investors to invest in assets such as shares, bonds and property. The profits from these investment are passed on to individual unit owners instead of being reinvested in the fund.

The nice thing about unit trusts is that they are managed by professional fund managers.

These types of investments do not require large sums of money to start off with. They offer flexibility, as investors are given the choice to decide what the frequency of their contributions will be.

Investors can choose to contribute monthly, annually, bi-annually or once-off and are given the freedom to change their contribution amounts and the frequency as it suits them.

These investments give the investor exposure to different asset classes and markets, and with this comes portfolio diversification.

Lastly, these investments are highly liquid, as you can access your money in as little as 72 hours. However, please keep in mind that when a withdrawal is done, it may trigger a capital gains tax event.

Fixed deposit vs unit trust

The table below illustrates how much interest you would earn per annum if you invested R100 000 using an average rate for the fixed deposit and the unit trust:

* The above average interest rates were sourced from Absa, FNB and Investec as of 30 September 2022.

Other options

If you seek interest rate exposure, you can invest in mutual funds such as money market funds and income funds.

The table below illustrates how much interest you would earn per annum if you invested R100 000 using an average rate for a money market fund and an income fund:

* The above average interest rates were sourced from Allay Gray, Nedgroup Investments and Foord as of 30 September 2022.

My suggestion …

My suggestion would be to invest your emergency funds in a unit trust instead of a fixed deposit, preferably a tax-free savings unit trust as it offers tax benefits, and you can access your money quicker without any penalties.

You achieve portfolio diversification, which helps your portfolio flourish and avoids the consequences that may come with putting all your eggs in one basket.

And the risk is lower as the difficult decisions are left to the fund managers.

That said, I cannot call a fixed deposit a bad investment as it has its own advantages. Whatever your decision may be, I hope the information and guidance I’ve provided will help you in your decision.