According to a recent Business Times article, Singaporeans can expect an average salary increase of 4.5% in 2014. That’s great news right? Well… I forgot to mention one little thing – the same article also mentions that once inflation is taken into account, that 4.5% salary “increase” is really only about 1.8%.
But what if you only get a raise of 3% or no raise at all? Then you’re stuck fighting a Hunger Games-style battle against your fellow Singaporeans without evening knowing it – over making enough money just to survive inflation.
Ssalaries aren’t the only thing being decimated by inflation. Your savings, whether you’re hoarding your money in a shoebox, savings account, or socking it away in CPF – are also taking a loss whether you realize it or not.
Wasn’t MAS Evaluating Inflation-Linked Bonds Already?
In July 2012, the Monetary Authority of Singapore (MAS), the gatekeeper of all things financial, was in the process of evaluating whether to issue inflation-linked bonds (also known as “linkers”). And then… *sound of crickets chirping* nothing!
Not until March 2013 anyway, when the Business Times ran another story on MAS’s decision to withhold issuing investment-linked bonds because it feared that premiums would be too high ($0.10 on the dollar or 10% for a 3-year bond), and that investor returns would be lower than Singapore Government Securities (SGS) if the inflation level fell below projections.
So as of today, inflation-linked bonds are currently in limbo.
How Inflation-Linked Bonds Help the Average Singaporean
Seriously MAS, the concern is appreciated, but totally illogical. Maybe if every investor dumped their entire non-CPF savings into 10-year investment-linked bonds, and by some miracle, inflation stayed under 2.5% for the next decade (the current CPF interest rate) – then the argument would make better sense.
Or perhaps MAS thinks that Singaporeans are too dumb to know why they should diversify their investments (but they do know because there are articles talking about it!).
I also wouldn’t go so far as to say that the rate of inflation will stay below 2.5% over the next 10 years – because even though housing prices are set to fall, food, transportation, education, and ESPECIALLY health costs will almost certainly rise in the future.
The whole point of having inflation-linked bonds is to give investors a full-proof hedge against rising prices so that every dollar you invest today is adjusted for inflation so that it’s worth the same amount 3, 5, 10, 15, or 30 years from now.
How Inflation-Linked Bonds Work
Inflation-linked bonds work similarly to normal Singapore Government Securities (SGS) bonds in that you’re effectively loaning money to the issuer (government in this case) in denominations of $1,000 (principal, also called “par” value) over a course of 2, 5, 7, 10, 15, 20, or 30 years (tenure).
Then there’s the coupon rate, which is a percentage of the bond’s par value that’s paid out to you every 6 months.
If the coupon rate of your $1,000 SGS bond is 5%, you’d receive $25 every 6 months.
But with inflation-linked bonds, both the par value and the coupon rate are price adjusted according to the increase in the inflation rate.
So if you have a $1,000 2-year inflation-linked bond and your coupon rate is 3% and inflation is 2%, your returns would look like this:
|Real Value of Bond||Inflation-Adjusted Value||Real Value of Coupon||Inflation-Adjusted Value of Coupon|
As the inflation rate climbs at 3% each year, your investment-linked bond grows at the same rate so that you receive $1,061 when your bond matures – which is the same $1,000 you initially invested that’s adjusted for inflation.
Singapore Government Securities (SGS) vs. Inflation-Linked Bonds
Let’s match Inflation-Linked Bonds against Singapore Government Securities (SGS) to help you understand why we need inflation-linked bonds.
For this comparison, let’s compare the following:
A $1,000 5-Year SGS Bond with a coupon rate of 2.5%
A $1,000 5-year inflation-linked bond with a coupon rate of 2%
And let’s just say the rate of inflation stays at 2.5% during that 5-year period.
|5-Year SGS Bond||Initial Bond Value||Real Value of Bond (Inflation-Adjusted)||Initial Value of Coupon (2.5%)||Real Value of Coupon (Inflation-Adjusted)|
|5-Year Inflation-Linked Bond||Real Value of Bond||Inflation-Adjusted Value||Real Value of Coupon (2%)||Inflation-Adjusted Value of Coupon|
So as you can see from this example, even with a lower coupon value, the inflation-adjusted bond would still beat an SGS bond hands down.
So maybe the next question is one we should all pose to MAS – why can’t we get some of these for our investment portfolio?
Would you purchase inflation-linked bonds if you could? Share your thoughts with us on Facebook!
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