Rules of thumb
Always take interest monthly rather than semi-annually
Over-60s have the option of receiving interest monthly, and the advantages of this are:
The interest rates are the same, and cash early is always better than cash later
Once the bond has been held for 12 months it can be redeemed at a cost of one interest payment, so early redemption would only cost one month’s interest.
Receiving interest semi-annually makes early redemption very expensive, and also removes the flexibility discussed more below.
Buying a 5 year bond and redeeming early is almost always better than buying a 2 or 3 year bond
Consider the scenario where you have decided to invest, but expect to need access to the money in two years time. You could either:
Buy a 2 year Bond, or
Buy a 5 year Bond and early redeem at the end of 2 years
A comparison of the monthly interest that would be earned over the first two year period is as follows. Because there is a one month penalty for redeeming a monthly interest bond early, there would effectively be no interest earned in month 24 for a 5 year bond redeemed early.
Interest payments on 2 and 5 year bonds
The option which provides the greater amount of income over the period is the better choice. The investor will receive:
24 monthly payments on the 2 year bond, but only
23 monthly payments on the 5 year bond.
So the investor should buy the 5 year bond as long as;
23 x Rate on 5 year bond > 24 x Rate on 2 year bond
A further benefit of using this strategy is that should rates be lower at the end of the 2 years, and you don’t 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 re-start option will provide access to those higher rates.
Similarly, when comparing 3 and 5 year bonds, the investor should buy the 5 year bond as long as:
35 x Rate on 5 year bond > 36 x Rate on 3 year bond
Split your investment into a few different tranches
Once a bond has been held for 12 months, investors have the option to redeem the bond should they need to, or to re-start the bond should rates have risen. Partial redemption is allowed, but re-starts can only be done for the full bond.
To provide the flexibility to re-start part of your investment, it makes sense to split it into smaller tranches. The benefit here is that if rates have risen, but may still rise further, it will be possible to re-start part of your investment, and delay restarting any remaining parts.
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