One of my youngest clients gave me a call a few days ago. She was direct to the point. “ I need to buy the bond that is currently on offer”. She was a few hours ahead of me as I had not seen it. They say that if you didn’t expect it, you probably won’t see it coming. I was a victim. The bond has a 12.5% coupon with a 12 yrs maturity.
One of our consultancy services is to make sense out of such investment decisions. See, one thing that is peculiar in finance is that even if it’s a science, there is no single fix for all decisions. Environment, purpose and timing contribute to every decision. With such an ambush, I had a few things to think about. I had to think on my feet otherwise I would lose my job. Three points; interest rate, portfolio mix and risk.
We analyzed the risk in the simplest way we could. 12.5% p.a means 12.5 shillings for every 100 bob invested per year. Not so bad. The fact that that rate is above 10% p.a means that the minimum number of years required to earn interest that equivalent to your capital is 10yrs. So, how about a 12 yr bond? 12 years? Pleasant!That means that if the client holds the bond to maturity, she would earn more interest than what she invests today…cumulatively. 12.5% * 12… The next thing attached to interest rate is inflation. The average inflation rate for the past few years has been below 7% sometimes falling below 5%. That means that the interest rate offered by the bond is almost double the inflation rate indicating value addition. The verdict on interest rate was a good pass.
Portfolio mix is a composition of different asset that compose your wealth. Vehicles, land, shares, bonds…etc. One creates a portfolio in order to diversify and mitigate against risk. So where do we place bonds in comparison to her other assets? When taking in a new investment, one needs to ask themselves if the asses will add or reduce the total risk. A bond is ranked as a risk free asset. Since the client had not bought bonds before, this was a new area. We actually had to take her through the process of investing through the CBK. For that reason, the bond got a pass.
Risk analysis is a very tricky affair in finance. This is because of the fact that the world is full of uncertainties. You basically can’t predict anything without an element of error. In fact, the key thing is reducing the error rate. Bond analysis are a always a beauty to analyze. Why? The probability of a government default or delay is very low. The near guarantee possibility is very high. For this reason, bonds are ranked as risk free assets. Having a risk free asset enables you to plan with certainty and avoid loss of wealth due to declining prices. The only negative is that you are capped from earning on future increase in prices since your interest is fixed. Due to the risk free characteristic, the bond got its pass on that too.
At her age, I wonder how many bonds she might own in 10 or so years if this works out for her. For sure its going to be a hustle free investment. However the verdict would change of you compare returns of other modes of investment like a greenhouse or land but not until you realize the exponential increase on the risk factor. All the best to the young investors investing in the bond market.
