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Teh Tarik Peng (AKA Iced Tea) With Elvin Hayden Liang: Laddering The War-Chest Of Certainty.

Saturday, March 14, 2015

I have not met Elvin before but that shouldn't surprise anyone. However, through our rather lengthy chats online from time to time, I know that he has a rather brilliant mind. When he mentioned bond laddering during one of our chats, I said it would make a great guest blog and, well, here it is.

I have read about bond laddering before but I did not know anyone who was actually doing it. Well, now, I do. Thanks for sharing, Elvin.

-------------

Hi AK,

Thanks for allowing me to share a post on your blog. It is indeed my honour! :D

Actually I'm glad I've found good natured people too!

Here's the post:

"Laddering The War-Chest Of Certainty"

As it is right now, we've been swimming in a low-interest rate environment (below 1%) for quite a while since the last spike in 2004 which was the onset of the SARS outbreak which shook our economy.
To illustrate the point of low interest rates, for your viewing pleasure:

Recent news reported that interest rates have gone up a fair bit above 0.9%. However, deposit rates are still low ( < 2%) nonetheless.
Ever since, many who are vested in the capital markets have seen much higher returns than bank savings rates and fixed deposits. However, I would believe there would be a group out there who have a distaste for risky investments such as equities and even corporate bonds.
Question they would throw to the floor: Where can I put my money, say for 1 year to maybe 5 years, and, at the same time enjoy a better than the Bank's savings account rate without risk?
Risk-free Assets
1. CPF - guaranteed interest with the lowest at 2.5% and now the highest at 6%! (more details at 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 - mainly kept active for transactions and intended spending / liquidity.
Well, lately, for people who are storing up a war-chest for investments in future, especially when trying to time the market, this is one strategy we could use, to ensure we have steady cash coming out at different time intervals to plant the seeds in opportune market failures. While aiding our cash flow, this is also good for dollar-cost averaging purchases. It is mechanical, routine, and keeps out fear using a sound strategy.
Why should we break up our war-chest to different time intervals? This is because, like in investing, it is difficult to time the market, hence every 5 years would be a good time-frame to capture the market at sweet spots to ride any uptrends. Similar to dollar-cost averaging, we can also use the same strategy to dollar-cost buying into SGS bonds (which have been made really easy to do).
Here is a rough sketch of what I have done using a Bond Ladder and how it looks like:




So the 5 year plan goes like this:
1. From this year to the end of next year (2015 - 2016) or Year 1, I'd budget out about S$1,000/month to buy the First Tranche of the SGS Bonds which will mature in 2020 (capital guaranteed and with semi-annual payouts) be utilised in future, when opportunity arises to buy in blue chips when they are at huge discounts (i.e. during financial crisis, shocks, failure)
2. In Year 2, I'll do the same, but will 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, I'll have my Tranche 1 maturing, which will then have the bond ladder revisited again.
Sounds good?
Well this actually makes sense to me, with an effective yield (weighted average) of about 2.51% for the entire ladder (18 years, net of purchase charges etc.). So other than preserving cash value for opportunities in future, what can we use it for? For those who are very conservative, this could be used to hedge against low housing loan interest rates conservatively since housing loans usually range from 15 -  30 years.
As purchasing a property is an investment decision, with risky leverage, one may decide to reduce risk by hedging it against an instrument which gives more guarantee and security. Similar when we decide to use cash for investments. Remember, the bond ladder is risk-free, well, except if the person who is constructing it runs out of cash. So it does help one cultivate a good disciplined savings habit! What's more, you could also sell off the bonds (may incur some price difference, but usually small ~1%) if you need urgent liquidity too.
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?

Visit Elvin's blog: here.

Read more blogs regarding bonds: here.

9 comments:

SMK said...

May be of use to people who are easily frightened by frequent fluctuations.

Not for me.

and I want to add bonds are also subjected to fluctuations and harder to deploy/reallocate than cash due to maturity periods and difficulty in timing the exits.

Siew Mun said...

In SGS Bonds price and yields are inversely retaliate. U will be subjected to sell at current bond prices should you want to cash out for other higher yield investments.

The Sun said...

Hi Elvin and AK,

Could you shed light on how retail investors can purchase SGS bonds?

SMK said...

exactly siew mun.

excellent succinct elaboration.

when that happens, can only hold to maturity.

elvinliang said...

Hi SMK , Siew Mun,

Nice of you to write in your thoughts.

The bond ladder is useful in this situation where it provides 2 things your normal fixed deposit can't:

1) higher yields,
2) predictable and planned staggered maturities.

Fixed deposits normally require renewal on a yearly basis, this doesn't optimise the deposit should one require a longer period to roll-over.

The ladder is meant to be a war-chest for accumulation, not an investment instrument, but of course placing emphasis on the above 2 points.

Furthermore, fixed deposits requires a lump sum to enjoy better promotional rates from the banks.

As for the flexibility to withdraw to tap on situations when you want to cash out whenever for higher yield investments, the person who structured his / her own bond ladder must be first comfortable with the idea of staggered maturities.

Yet the person structuring the bond ladder would need to also set aside some amount perhaps in a fixed deposit in case he/she needs an additional flexibility to withdraw cash from.

This is for diversification, and not meant as a one trick solution.

Hope this helps!


epsilonluxe said...

Hi The Sun,

One can purchase SGS bonds from any of the local 3 banks, DBS, OCBC and UOB.

Here is the list of local dealers:

AUSTRALIA & NEW ZEALAND
BANKING GROUP LIMITED
10 Collyer Quay
#30-00, Ocean Financial Centre
Singapore 049315

BANK OF AMERICA,
NATIONAL ASSOCIATION
50 Collyer Quay, #14-01
OUE Bayfront
Singapore 049321

BARCLAYS BANK PLC
One Raffles Quay
South Tower, Level 28
Singapore 048583

BNP PARIBAS
20 Collyer Quay, #01-01
Tung Centre
Singapore 049319

CITIBANK, NA
8 Marina View, #21-00
Asia Square Tower 1
Singapore 018960

CREDIT SUISSE AG
1 Raffles Link, #03/04-01
South Lobby
Singapore 039393

DEUTSCHE BANK AG
One Raffles Quay
South Tower, Level 17
Singapore 048583

DBS BANK LTD
6 Shenton Way
DBS Building Tower One
Singapore 068809

THE HONGKONG AND SHANGHAI
BANKING CORPORATION LIMITED
21 Collyer Quay, #14-01
HSBC Building
Singapore 049320

OVERSEA-CHINESE
BANKING CORPORATION LTD
65 Chulia Street, #09-00
OCBC Centre
Singapore 049513

ROYAL BANK OF SCOTLAND plc
One Raffles Quay
South Tower, Level 26
Singapore 048583

STANDARD CHARTERED BANK
8 Marina Boulevard, #27-01
Marina Bay Financial Centre Tower One
Singapore 018981

UNITED OVERSEAS BANK LTD
80 Raffles Place
UOB Plaza
Singapore 048624


You can also purchase the bonds via the Fundersupermart website on the iFast platform. Hope this helps

SMK said...

Elvin,

I will show you a real live example of what I mean when I wrote above that a so called "bond ladder" (but actually just a name place holder to describe purchasing bonds of varying maturities and yields OR purchasing bonds in series) is really used as a way of fixed income investment but is not always useful for warchest accumulation.

We will have to wait a while though for the example to appear and I hope I will remember to show it here.

You can also do a historical exercise and find that bonds prices and stocks prices do fall in tandem as well and by when both rises, it is too late to reallocate.

otherwise warren buffet will be using a series of bonds instead of cash a call option with no expiration.

Elvin Liang said...

Hi Siew Mun,

I guess we are on the same page and recognise that:

1) bonds are an investment tool as they give fixed income (albeit higher than fixed deposits)

2) our capital is guaranteed upon maturity

3) we may have to wait for them to mature before being able to utilise them for riskier investments

4) It is more affordable vs buying retail bonds and is less risky than equities or funds.

Hence this being said, it should not be the one and only tool to use. It'll be foolish to dump all eggs into one bond ladder.

However, for those starting out with savings, this is perhaps one disciplined way to dollar cost average and at the same time have a better return than the fixed deposit with semi-annual payouts.

We also need to establish that the bond investor will need to be comfortable with the maturities of the bonds, meaning, to avoid touching the SGS bonds until they mature, to avoid any potential capital loss.

Personally, my portfolio consists of equities, funds and property. Hence, this is just one instrument I have constructed as a means of cash accumulation, so that perhaps in 2020, I may use it for other investments (if situation permits) / loan repayments.

SMK said...

Pop!

There goes the bond ladder.

http://www.mas.gov.sg/~/media/resource/news_room/press_releases/2015/Factsheet%20Savings%20Bonds.pdf

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