Low-interest rates have been around the last 6-7 years (below 1%) after the 2008 financial crisis. As seen in the graph below, there is a hint or a possibility that asset bubbles are likely to cause interest rates to rise.
Over the last week, we saw local interest rates climbing up slightly over the 0.9% mark, but we still see that deposit rates have yet to respond and are still considered low ( < 2%).
I’ve gotten many questions from Singaporeans but the most common question received would be: Where can I save regularly and yet not have my savings subject to risk (loss of capital), yet be able to have a better return / yield compared to the bank account or fixed deposit rates, say in 1 – 5 years?
By distilling the question down, we have 3 requirements that needs to be met:
1) save regularly
2) no risk of capital loss
3) better yield than the bank account /fixed deposits
1. CPF – guaranteed interest with the lowest at 2.5% and now the highest at 6%! (more details at http://www.cpf.gov.sg)
2. Fixed deposits – low interest rates of between 1 – 2%
3. SGS Bonds – Though they are in the bond family, which is typically an investment, SGS bonds are government backed, hence with Singapore having a good credit standing, risk of default is extremely low.
Interest rates vary between 0 – 2% for 2 years and 2 – 2.5% for about 10 years and 2.5% – 3% for about 20 years.
4. Local bank account – generally below 1%, those that generously tout above that require certain conditions to be fulfilled. Bank accounts are usually utilised for spending activities or for liquidity.
How does a bond ladder benefit an individual?
1) Aids liquidity which doesn’t require a lump sum / large sum to be locked up
2) Good for dollar-cost averaging SGS bond purchases. This technique manages risk.
3) No capital loss at bond maturity.
4) Semi-Annual payouts which can be channelled for other use.
5) Expect regular maturities every 5 years, which can then be used for other riskier investments.
6) Versatile as one can select different bond maturities which suit one’s preferred time-frame.
To illustrate a bond ladder which I’ve constructed, take a look at the timeline below:
So how does this ladder work?
1. In Year 1 (2015), I’d budget out about S$1,000/month to buy the First Tranche of the SGS Bonds which will mature in 2020. This tranche may be used when the opportunity arises to invest in heavily discounted blue chips in market failures or financial crisis.
2. In Year 2 (2016), the same step is taken to purchase SGS Bonds in Tranche 2, which matures in 2024.
3. In Year 3, … Tranche 3, matures in 2029.
4. In Year 4, … Tranche 4, matures in 2033.
5. In Year 5, … which is 2020, Tranche 1 will be maturing, which will then have the bond ladder revisited again.
Making Sense Out of the Ladder
With an effective yield (weighted average) of about 2.51% for the entire ladder (18 years, net of purchase charges etc), one can use the ladder to:
1) Hedge against low housing loan interest rates conservatively since housing loans usually range from 15 – 30 years.
2) Accumulate funds in a disciplined and measured way with certainty of capital preservation for use in future.
3) Diversify cash based assets with a higher return than keeping cash itself.
Many a time, property investors leverage to acquire property for investments. However, the loan size is usually large. Hence, one may decide to reduce risk by hedging it against an instrument which gives more guarantee and security.
Remember, the bond ladder is risk-free, well except if the person who is constructing it runs out of cash and needs to sell off the bond. Just to note that the SGS bond prices may fluctuate throughout time. However, closer to maturity, the prices will converge to it’s par value (typically S$1 per script of a bond).
The SGS bond yields are tax exempted in Singapore, making them favourable for foreign investors as well.
In unexpected scenarios where there is a need to liquidate all assets, you could also sell off the bonds (may incur some price difference, but usually small ~1%) if you need urgent liquidity too. However, this should not happen as it is important to set aside sufficient liquid funds for emergency, and separate funds for investment purposes.
What do you think of a bond ladder? Would you think it wise to put all your cash into property or the capital markets rain or shine?