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

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.

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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.