30 August 2010

Bonds and bond laddering

Singapore Government Securities (SGS) bonds are available for the retail investor like you and I.  I'm not sure how one can go about buying them, but for sure it can be done at Fundsupermart.  How does it work?

SGS bonds gives out coupon payments twice a year, based on the coupon rate of the particular bond series.  The family of SGS bonds have varying maturity date up till 20 years.  If kept to maturity, a SGS bond of $1,000 face value (a.k.a. par value) would return in cash the face value.  So long as it is kept in your holdings, you will continue to receive the coupon pay outs.  That means that SGS bonds is a good way to receive a regular payment stream. 

One approach to keep bonds over the long term is to hold bonds with different maturities.  Each time one matures, reinvest to the longest dated bond.  This is not dissimilar to the notion of Regular Savings Plans (RSP).  In this way, we spread the risk over the price at which a bond is bought by simply buying different years for different maturities.

The bonds are bought and sold on what is referred to as a secondary market.  While the face value may be $1,000, the price being bought or sold at would vary.  As a result, the real "yield" achieved from the annual payout would differ from the coupon rate.  So we would be looking at the yield to determine the rate of return, rather than the coupon rate.  However, if you were studying cash flow, you would be looking at the coupon rate instead.

The yields have not been great of late, having depressed to below 3%.  At the peak of the market panic a year or more ago, the longer dated bonds were at yields of 4% at one point.

One obvious flip side of SGS bonds is the liquidity. If you had to liquidate the bond by selling on the secondary market, you may not necessarily be able to do so at a price better than when you bought it.  That would depend on the market condition.  Even then, it is unlikely to vary that much.  Over the last two years, I've seen fluctuations by +/- 10%.

Taking an extreme example, suppose one held $1,000,000 worth (face value) of bonds, and the bonds had coupon rates averaging 3.6%, that means one would receive $36,000 each year, guaranteed.  That's $3,000 per month.  Perhaps not a bad retirement strategy.  That's of course, if you're happy enough with 3.6%.

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