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Avoid this in a rising interest rate environment.

Saturday, May 7, 2022

Many say cash is trash because inflation shrinks the value of money.

However, in an environment where interest rates are rising rapidly, there is something which is worse than holding cash.

At least, we will not have the possibility of negative returns when we hold cash.

We will get paltry returns but not negative returns.

Possibility of negative returns?

Yes, not only possibly but also probably.

Alamak! 

So, what is this terrible instrument of wealth destruction?




Long time readers will know where this is going.

I am talking about bond funds, of course.

If you cannot remember or if you are new, this was what I said a few years ago in an interview with The Fifth Person:





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1. Cash is trash? 

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17 comments:

Siew Mun said...

Pare down mortgage loans too. Rising interest with eat into your monthly income if one has mortgage loans

AK71 said...

Hi Siew Mun,

It is a good idea for added peace of mind.

However, if the mortgage is pretty modest and if we are able to get higher returns compared to the interest on the mortgage, it might be a better idea to be invested.

D said...

How long is considered long for bond?

AK71 said...

Hi D,

Any bond that is longer than 10 years is considered long term.

So, if we get into a long term bond now that pays a coupon of 2.5% per annum, for example, and new bonds are issued in the following months with higher coupons, we are in a bad place as we are stuck.

Short term bonds are more attractive in an environment where interest rate is increasing rapidly.

The exception would be Singapore Savings Bonds but those have a maximum holding period of 10 years only.

The same principle applies to fixed deposits when interest rates are increasing rapidly.

TK said...

Dear AK,

Would this apply to Bond ETFs like A35 and MBH as well? Thanks!

AK71 said...

Hi TK,

Bond Exchange Traded Funds (ETFs) are bond funds.

When interest rates rise, the unit price of bond funds will naturally decline.

Hello said...
This comment has been removed by the author.
AK71 said...

Hi Wei Yi,

I cannot make a choice for the couple.

So, I have published my reply as a blog to see what others have to say.

See:
Sell property and retire from work?

Hello said...

Thank you sir. U are right. Spending time with kids is priceless. Appreciate the perspective!

AK71 said...

Hi Wei Yi,

Unless we don't have a choice, no amount of money can compensate for the loss of quality time with family. :)

DS said...

Hi AK, would SSBs be considered as bond funds as well? Was considering it cus the latest tranche hasan average interest rate of 2+%

Thanks in advance! :)

DS said...

AK, paiseh, not too sure if my earlier comment got through. Wanted to ask if SSBs are considered bond funds? Caught my attention as its interest has been increasing!

AK71 said...

Hi DS,

SSBs are bonds but they are safe because we are allowed to redeem at any time without suffering any capital loss.

This is because SSBs are designed by our government to give those who are risk averse another money saving option.

Bond funds are risky but SSBs are risk free.

Of course, in order to enjoy the highest coupon, we would have to hold the SSB for the full 10 years and we are also allowed only $200K max of SSB at any one time.

Siew Mun said...

I do encourage people to park their emergency funds in SSBs. I been holding $90k since 2018/2019 era. Looking forward to add more this time round. I have also gotten my daughter who is working to park her emergency fund in SSB

AK71 said...

Hi Siew Mun,

With interest rates higher and going even higher, the SSBs make sense.

If we can eventually get a risk free rate of 4% or higher from SSBs, it becomes an absolute no brainer to park some money in SSBs for those who can afford to do so.

However, we have to bear in mind that to get the maximum coupon, we would have to hold the SSBs for the maximum of 10 years.

So, if we park our emergency fund in SSBs, we might not get the maximum coupon.

Siew Mun said...

Agreed interest is step up. Emergency funds are by nature for urgent use and should be somewhat available on demand. As such earning good interest is a 'bonus' rather than a given.

AK71 said...

Hi Siew Mun,

Yes, as long as we know that we might not be able to get the maximum coupon and also the fact that SSB doesn't provide instant access to our money in the event of an emergency, then, it is probably OK to park some of our emergency fund in it.

For me, SSB isn't ideal for all of my emergency fund because I could need the money right now or the next few days at the latest in an emergency.

I blogged about the SSBs many years ago when expectation was for interest rate to rise.

Maybe, I should take some of the salient points for a new blog post. Just maybe. ;p


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