Buy Term and Invest the Rest?

This is a reply from Brendan, in response to my post, Is this a Good Deal? – Great Eastern Annual Cashback Endowment Plan. Brendan has gladly allow me to post it here. This will be his first guest post! (Brendan is an Investment Specialist and Financial Advisory Director at SingCapital.  He is currently teaching other financial advisers/practitioners in Module 4: Investment Planning under the CFP® program. He is also a sought-after speaker and a MoneySense representative.)

Hi Alvin,

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Good point about the long term benefits of buying term invest the rest. Of course as you mentioned, the investor needs to be able to stomach the risks associated with the stock markets.

If they only employ a buy-and-hold strategy, the confidence would really be shaken in a worst-case draw-down scenario. In the 2008 financial crisis, it would be -62.3% (STI from 3862 to a low of 1456). To any non-investor, it would be really scary.

May I propose an alternative comparison? Let’s compare the endowment with lower risk instruments: (1) preferred shares, (2) bonds or even a (3) balanced unit trust fund.

OCBC 5.1% Non-Convertible-Non cumulative preference shares’ current yield 4.9% at price $104. Meaning they will pay a perpetual $5.10 per $104 share. Price volatility of the share is much smaller. OCBC NCPS 5.1% fell to a low of $90.00 (a 14% drop from $104) in 11 Mar 2009. Risks are that they may redeem the share (likely when they can issue new NCPS at lower interest, therefore you may suffer a bit of reinvestment risk) or not pay the dividend (unlikely if they want to keep their reputation intact).

Bonds however, will not have non-paying dividend risks. For example a quasi-government body like Land Transport Authority 4.08%pa (maturing 2021) bond, trading at $1.015 yields 3.89%pa, is another good alternative. Incidentally it has never went below $1.00.

Balanced Funds are weighted with equities and bonds. Fund managers may have different mandates for ratio of equities vs bonds. Picking one to benchmark is not straightforward. However for sake of simple comparison, I’ll bring out 2 possibilities.

One is Lion Global Singapore Balanced. The fund manager’s mandate is to hold 60-70% in STI component stocks and the rest in SGD bonds or cash. In the last 10 years it has returned 7.76%pa (CAGR), with a volatility of 11.49, worst-case draw down (during 2008 financial crisis) of -37.5%.

The other one is First State Bridge. It has a mandate to re-balance monthly to 50% Asian Ex-Japan equities and 50% Asian Bonds. It has achieved 6.79% (CAGR), 10.3% volatility for last 9 years, worst-case draw down of -35.3% (during the 2008 financial crisis).

Using OCBC NCPS 5.1%, LTA 4.08%, dividends reinvested, and Lion Global Singapore Balanced as a comparison, here is my adjusted table.

Why would I want to be subject to a non-guaranteed insurance company payout vs a LTA guaranteed bond? Minor issue will be the coupons/dividend which does not have an auto-reinvest option, but I’m sure I can find viable alternatives later on.

As an investment instrument, seriously I never considered endowments a viable option, even as a financial planner. The high commissions is tempting though. As an advocate of buy term invest the rest, I concur with your observation.

Brendan Yong