Investing in government retail bonds

Government retail bonds

The first step in your financial journey is always to pay off short term debt and then to save an emergency fund. Only then can you start investing. Usually, my advice here would be to stick to well-diversified local and international Exchange Traded Funds (ETFs). Recently, however, the government retail bonds have started looking extremely attractive.

Government retail bonds are simply money that you loan the government that they agree to pay back at a certain interest rate. Traditionally South African government retail bonds have yielded about 8.5%, which is decent. The drawback has always been that the yield on bonds is added to your taxable income. This means that there is a good possibility that you will be paying more than 30% tax on the yield. So what has changed?

Why government retail bonds are attractive

The short answer to this question is that the yield has recently gone up from 8% to 11.5%. I should, however, specify that this is if you take a 5-year bond. So, if you really want to get the best out of bonds you need to be able to invest for the long-term.

The reason why bonds make up a part of Retirement Annuities (RA) is that the returns are extremely predictable. This adds stability to your portfolio since it has zero volatility. This is valuable when you are nearing retirement and can’t afford price volatility. Since they are government-backed they are also low-risk investments as discussed in my article risk identification in your portfolio.

The yield of the bonds is established in the month that you buy them. In other words, if you buy them this month (while the yield is 11.5%), you will earn 11.5% for the duration of the bond.

However, you can reset the bond yield if the yield increases while you hold the bond. The only caveat is that you must hold the bond for 12 months before you can reset the yield. This not only resets the yield but also restarts the 5 years that you hold the bond.

I mentioned that the drawback of bonds is the tax you pay on the yield. For me, this is not such an issue since my wife is not working at this stage. So I can buy all the bonds in her name to ensure that we pay minimal tax on the yield.

Historic yield

The historic yield of bonds can be seen below. You will notice a nice jump at the end of the graph.

The yield on South African government retail bonds varies between 7% and 11.5%. The last time the yield was above 10% was during the 2008/2009 recession. I am no economist, but it looks like the government tries to make bonds attractive during times of economic struggle. Possibly to avoid having to borrow money internationally, which they did have to do this month (to the tune of R19 billion).

With the yield at 11.5%, it is the highest it has ever been. I don’t know if it will go any higher than this, but if I was a betting man, I’d say this is the best yield that you are going to get for a while.

Bonds compared to alternatives

With ETF investments you can realistically achieve a growth of about 12% to 14%. However, the returns have lately been significantly less. So compared to shares, you will probably earn a little less over the long term. The bonds will, however, have zero volatility and are low-risk investments.

Compared to money in the bank, bonds are also looking attractive since the best yield you can get in the bank is 10.75%. You can view all the rates that the banks offer in my article South Africa’s best savings interest rates. With cash investments, you are also at risk of losing your money if the bank fails, whereas the government can just print more money. This will dilute the currency, but you will get your money back.

Compared to leaving your cash investments in your home loan, bonds are also looking extremely good. The prime interest rate has come down to 7.75%. This means that you can be earning 3.75% more if you can avoid touching the money for five years.

I do not recommend buying them instead of maxing out your Tax-Free Savings Account (TFSA) or your RA. However, they make a nice addition to your discretionary investments after maxing out both your TFSA and RA. A lot of RAs also contain bonds already, however, the returns will differ as they were bought at different times and can include international bonds as well.

Where and how do you buy bonds?

The best way to buy bonds during the lockdown from the convenience of your home is through the website RSA retail savings bonds. There you simply open an account by filling in all your information. You then get an investor number that you use to log into your account.

Once in your account, you simply click on apply for bond. Then you choose the bond that you want to own. You can either choose fixed interest bonds that offer a consistent return or inflation-linked bonds that track inflation. The bond offering 11.5% is the 5-year fixed interest bond.

You then enter the amount you want to buy and click submit. The minimum amount that you can invest is R1000 (maximum R5 million). You can choose to reinvest the interest automatically or pay it out semi-annually. If you are older than 60 you can also choose to pay the interest out monthly.

The website will then give you banking details where you need to pay the funds, using your investor number as a reference. Ensure that you pay the same amount as you applied for to avoid confusion. The whole process should not take you more than half an hour.

Alternatively, you can buy bonds at the post office. I have not done this personally, but I assume it won’t be too much of a hassle. However, you decide to buy bonds, I quite like the returns they are offering and have also started diversifying into bonds.

Be safe out there,

Hendrik

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Endnote

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Comments

  1. John

    Thank you for making bonds simple. I’ve been trying to figure them out for a while.

    Where it gets complicated is on the secondary market (which is all most investment advisors and websites talk about), where the price of the bond and the yield are inversely related, so if SA’s bonds get a little cheaper (their yield goes down, say) the price of all the old bonds in circulation change. I.e. if I can by a new bond at 10%, the old bonds (which gave 12%) become 20% more expensive on the secondary market (because they give 20% more yield). Thus I can hold a bond for much less than 5 years and make a killing (or a big loss), if the rates change. The fact that you get the capital back at maturity just complicates the maths further.

    Most of this is irrelevant if you buy the bond yourself.

    Personally, my biggest problem with RSA bonds, is that SA is in the process of tanking like Zimbabwe did 20 years ago. It’ll take time but you have to subtract the rate of rand depreciation from the rate you get on the bond. The fact that SA’s government bonds have increased to 11.5% is a direct result of the ratings agencies saying that they think SA is mismanaging their finances.

    The more debt SA has, the better the bond yield will be because the risk of them not paying one day keeps increasing. More than half of SAs costs (public wages and social grants) are increasing around 9% per year, while the tax income is maxed out (or shrinking). We are currently spending 6% per year more than we make and debt servicing costs are increasing by 3% of our budget every year and recently passed 15% of our budget. This was before COVID 19 knocked us for six.

    My conclusion is that there is little doubt that SA is heading for a major problem in the next 5 years. Either they have to cut wage and grant spending (unions then make the country ungovernable) or they have to default / massively devalue the currency to wipe out the rand denominated portion of their debt (the bonds you are talking about are easier to service at R50/USD). The only sustainable way out is major structural reforms, such as stopping corruption, stopping salary increases for government workers, ending BBBEE and AA, making it easy to fire people, etc. That is simply not palatable to most of the people in the country. Bottom line: For the next 10 years, the only way to reduce the cost of debt is to devalue the currency.

    This basically means that Rands are going down and not coming back. I advise that you get what you can offshore as soon as you can. I know that’s depressing but I recently graphed the value of my ZAR investments in dollars and the value destruction going on in SA is truly horrifying. I recommend that you seriously consider putting all your monthly investments in Ashburton 1200 rather than Satrix 40 or property. Personally, I am not putting any new investment in SA – my house and pension already give me more local exposure than I really want.

  2. Post
    Author
    Hendrik Brand

    Hey John,

    Thank you for the in-depth response. I’ll be honest and say that I had to mull this over quite a bit. You bring up really good points and you have obviously put a lot of research into this.

    I don’t think that we are on track to end where Zim is at this stage. I think that the rand will continue slipping but not by hyperinflation. Obviously that is just an opinion. I agree with you that it is better to invest in the international market at this stage and the Ashburton 1200 or the MCSI world products will get you there. A small portion of our cash will have to remain in SA and I think for a bit of stability, bonds are a good option. Well at least better than keeping it in your home loan at this stage. Would I risk my entire portfolio on bonds? Never.

    I’m an optimist at heart so I might also be entirely wrong. There are definitely things that have to be done to turn the economy around and some of it might hurt. I sometimes wish I studied economics. Maybe other people can chip in on this as well to get a better idea of what the majority of the country thinks.

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