Buying a 5-year Bond and redeeming early is usually a better option!
Better rates are often available via early redemption of bonds paying interest monthly
Once a bond has been held for 12 months, it can be redeemed at a cost of one interest payment. As over 60’s can elect to receive interest monthly, this means the cost can be just 1 month’s interest.
So there are times when buying the 5-year bond and redeeming after 2 or 3 years, gives a better return than just buying the 2 or 3 year bonds. The situation as at September 2017 is as follows:
Fixed Rate RSA Retail Savings Bond Rates (NACM)
|Term (Years)||RSB Rate %||Effective Term||Effective Rate %||Improvement %|
|2||7.50||5 year bond redeemed after 2 years||7.91||+0.41|
|3||7.75||5 year bond redeemed after 3 years||8.02||+0.27|
Strategy Interest Cash Flow Comparison Table
|Date||2-year Bond||5-year Bond
Redeemed after 2 years
|7.50%||8.25% + 1 month penalty|
Using the levels above, the alongside table compares the cash flows for a R100,000 5 year bond redeemed after 2 years, versus the same investment in a 2 year bond.
The total cash flow received from the 2-year bond will be R15,000 at a monthly rate of 7.50%
The total 5-year bond’s cash flows over the same two years, including a penalty of one month’s interest, amounts to R15,812.50, or R7,906.25 per year, i.e. a monthly rate of 7.91%
An up to date comparison for both 2 and 3 year periods can be found at BondClub Market Data
For those interested in doing the calculations themselves, the following formula can be used:
2 Year effective Rate = 23/24 x 5-year Bond Rate = 7.91%.
So in the example above 23/24 x 8.25 = 7.91
3 Year effective Rate = 35/36 x 5-year Bond Rate = 8.02%.
So in the example above 35/36 x 8.25 = 8.02
A further benefit of using this strategy is that should rates be lower at the end of the 2 years, and you do not need to withdraw the money, you have the option to stay invested at the original 5 year rate. Conversely, if rates happen to be higher, then the restart option will provide access to those higher rates.
NB: This strategy only works effectively for Bonds that pay interest monthly, and this is an option only available to those over 60
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