Are RSA retail bonds an option for a pensioner requiring monthly income?
From time to time Rosebank Wealth Group addresses reader’s questions from Moneyweb. Our answer to the following question is posted below: Could you please give your opinion on investing in RSA saving bonds as a pensioner requiring a monthly income? I am 77 years old and the five-year interest rates look very competitive. What are the risks here?
RSA Retail Savings Bonds are available as either Fixed-Rate Retail Savings Bonds (available over terms of two, three or five years) or Inflation-Linked Retail Savings Bonds (which mature after three, five or 10 years).
These bonds are effectively loans to the South African government, with a promise to pay back the capital after the term in question, along with interest, payable as described below. The minimum amount that can be invested is R1 000 and the maximum R5 million.
Fixed-Rate Retail Savings Bonds earn a market-related fixed interest rate payable on the interest payment dates until maturity. Different interest rates apply to each of the maturities in the series as per the table below. Investors in these bonds can choose to reinvest their interest, have it paid out twice a year on the interest payment dates (March 31 and September 30 each year), or in your case, as you are over 60 years old, receive their interest payments monthly. These fixed-rate bonds also have a ‘restart’ option. This enables the investor to restart the term of the bond at a new prevailing (possibly higher) interest rate after 12 months, or to change the investment term.
For example, if you invested in the five-year fixed-rate bond when the interest rate was 7%, after 12 months you could restart the five-year term if the interest rate increased to 8.5%. After 12 months you would also be given the option to change the duration of the bond, either to a two- or three-year bond.
The Inflation-Linked Retail Savings Bond series consists of bonds with a three-, five- or 10-year maturity. Capital amounts invested in these bonds are inflation-adjusted over the term. A floating interest rate is payable every six months on the interest payment dates.
Now we will turn to your question and identify three risks associated with a Fixed-Rate Retail Savings Bond with a five-year term.
Inflation risk: While interest rates usually remain fixed for long periods and inflation rates are generally more volatile, the risk is that your interest rate might become uncompetitive. The current rate of 8.5%, which is a real yield of about 4% per annum after inflation is factored in, could become a negative real yield (earning less than inflation) if inflation increases. This could be negated by the restart option, which does allow you to restart your term at the prevailing rate of that month once you have been invested for more than 12 months – if, of course, a higher interest rate is available to choose from at that point. If you think inflation might be on the increase at the time of your investment, you could choose to buy an inflation-linked bond at the outset.
Income risk: There is a risk that the income you earn from your bond holding will not increase (in nominal terms) unless the interest rates increase, or you use the restart option. Over several years (when inflation is expected to increase), your income may not increase at the same rate, bringing its purchasing power down (decreasing income in real terms). Note that the restart option is not available if you buy an inflation-linked bond.
Default risk: Effectively, you are lending money to someone (in this case, the SA government), so there is the risk that your money cannot be paid back to you. In this case, the risk (that the SA government defaults and cannot repay debts, or pays you less than they owe you) is low. Nonetheless, the risk exists and is a reason for diversifying your investments. A core investment rule is to never have all your eggs in one basket.