Are bonds right for me?  
Published by JamaicaObserver.com on Sep 04, 2005
Written by Charles Ross
Sep 05, 2005

Despite the fact that the Jamaican government has been active in international bond markets since the 1990's, many Jamaicans are not aware of the very attractive investment opportunities that these US dollar denominated securities can offer to investors.

For many people with money to invest, the first thing that comes to mind is either a bank account or a repurchase agreement (repo) with a securities dealer.

While a bank account may pay interest at rates of two to 3.5 per cent and a repo may offer a return of four to 5.5 per cent, both are subject to withholding tax; plus, there are Government of Jamaica bonds that can offer tax free returns of over eight per cent!

These differences in yield are not large in absolute terms, but are significant in relative terms; over time, they will add up to substantial differences in the eventual value of one's investment.

For example, the table below shows how the final value of an investment of US$10,000 will vary depending on the rate of return that is earned on that investment.

This table vividly demonstrates the power of compounding, and the significant difference in the value of medium- to long-term investments that can come from seemingly modest increases in the return on those investments.

After five years, the bond will have earned about 32 per cent more than the bank account and about 20 per cent more than the repo. However, after 15 years the gaps between the various investments have grown much larger. The return on the bond ($33,069) will be 228 per cent greater than the return on the bank account ($14,483) and 170 per cent greater than the return on the repo ($19,353).

Bonds, banks and repos

The first thing that these results tell us is that people who are investing for the medium- to long-term should seriously consider investing directly in bonds since there are very significant gains to be made over investing in bank accounts or repos.

While these two latter instruments may be appropriate for short-term investments - under 12 months for example - investing or saving for longer periods, such as retirement or a child's education, should examine the higher returns earned on bonds.

There are a number of reasons why bonds offer higher returns than repos or bank accounts, and they are related primarily to the risks associated with investing in bonds.

While the credit risk associated with a Government of Jamaica bond is not significantly different from that of a Jamaican bank account or repo, there is the price risk associated with bonds. Like any financial security, bond prices can go up and down.

If the price is higher when you want to sell it than it was when you bought it, you will make an extra profit on your investment in the bond. However, if the price has decreased on selling the bond from when initially bought, then you will make a capital loss, and this will lower the overall return earned on your investment.

For the medium- to long-term investor, fluctuations in bond prices are a relatively minor issue, as the investor has locked in his or her return at the time of purchasing the bond. The sailing should be smooth for this investor, as long as the government continues to honour its debt obligations.

On a final note, investing in bonds is a bit more involved than putting money into a bank account. If considering bonds as your primary instrument, seek advice, risk analysis and detailed information on the investment from your advisor before purchasing.

Fortunately, the higher returns anticipated on the investment will more than compensate for the extra effort involved in arriving at the selection.

Charles Ross is managing director of Sterling Asset Management Limited. Sterling provides medium- to long-term financial advice and instruments in US and other world market currencies to the corporate, individual and institutional investors.

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm.

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