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.
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,
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