Sunday, 28 February 2016

Creating a Bond Ladder


I spent the last few weeks finishing a book bought during Christmas. (I skip some irrelevant chapters in between and focus on the gist of the book). 

Considering my workload, this is actually quite an "achievement" and I didn't have to travel for work in Feb helped tremendously.  

Bond Ladder

I will assume you know what a bond is. I have blog about a few retail bonds that IPOed last year. You can read about them here

I am not sure if you had heard of a bond ladder but basically what it means is that you buy a series of bond papers at regular intervals and hold them till maturity

Each bond pays you interest twice a year (typically) and the principal amount at maturity. Assuming you repeat that process every month, you will create a portfolio that gives you a stable and predictable cash flows similar to that of a paycheck. If you have no use of those interest, you can reinvest them into bonds to enjoy the magic of compounding (similar to your CPF accounts). 

Unlike dividends, the interest and principal repayment is an obligation by the company to repay. As such, cash flow is predictable as long as the issuer is solvent and able to repay and your capital is returned at maturity.

Why can't the man in the street create a bond ladder?

The key issue in Singapore is the capital outlay as the bond market here is not fully developed. 

Each bond typically requires $200,000 a certificate and are not offered to the man in the street! I can't afford $200,000 each time! 

The regulations are finally changing!

You will be heartened to know that regulations is changing here. MAS is (after much lobbying from others) trying to make it easier for corporates here to issue bonds to retail investors. You can read the MAS consultation paper here.

Setting distribution costs aside, it is currently legally more onerous to issue corporate bonds to retail investors than to accredited investors but this is likely to change soon.

Regulators should have incentives in place to encourage issuers to issue bonds to retail investors like you and me.

In the next 10 months, I definitely hope to see more blue chip and reputable corporates issuing retail bonds in more palatable bite sizes (say in tranches of $2,000). With current technology, I don't see why the bite size can't be even lower.

With smaller bite sizes, it will also be easier to create a more customized bond ladder and allows you to mix and match issuers of different quality and interest rates to diversify against over concentration.  
Credit standing of issuers are important

The book which I was reading encouraged only investment grade bonds. That means the bond ratings by S&P, Moody's and Fitch are at BBB or better (A, AA and AAA). 

Buying a bond issues by credit worthy companies ensure very low risk of loss on the original capital and let you sleep soundly at night. 

How much do you need each month?

Each person has different values and life styles. Do you like to travel? Do you wine and dine a lot? Do you have family to take care of? Do you want to donate to charity? 

I have recreated a simple bond ladder for you. This is how it would like once we can invest in bite size amount and you manage to create a portfolio of $600,000. In a steady state condition, it would look like this:


If you refer to the table above, a final capital size of $600,000 yielding 4% will generate a monthly income of $2,116 in a steady state. If your lifestyle warrants a higher capital amount, then you should adjust accordingly and invest more. This monthly income can of course be supplemented by your other passive income sources like stocks and properties.

Can i create a bond ladder today?

You can if you have a large capital to start with. You can call you broker for a list of bonds traded. Please see an example of bonds traded in Singapore here which i get from my broker. 

As i mentioned above, it will cost you around $200,000 to $250,000 for most of them. Most secondary bonds are traded Over-the-Counter. (I haven't bought any bonds from the OTC market yet).

My first bond purchased was made in October last year where i bought Perennial Real Estate Bonds. You can read the write up here. I have yet to receive the first interest amount.It will come in April this year! 

Get ready for it

The further development of the retail bond market is good news for you and me. We can start to create our passive income in smaller amounts but i would recommend going for the blue chip names for a start even though the yield is lower but you would want to sleep soundly at night.

That is it for today. I will blog more about my activities in SRS in another post.

Happy Bonding.

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