Tuesday, May 19, 2015

DIY "Capital Guaranteed" 4.3%pa Structured Deposit with FCL Bonds

For whatever reason, there is huge huge interest in the FCL 3.65% 7 year bonds. I think they are only all right. Lots of people have covered about them as an investment in great detail, and why you should own them and why you shouldn't, so I won't talk about that.

Personally, I'm not subscribing. I am fairly certain that within 7 years there will be an opportunity for me. Plus, with the yields I am getting on my liquid cash, the opportunity cost is not startling.

However, I think this is a good time to show an example of how you can make your own "capital guaranteed, return guaranteed investment product". I will be using the FCL bonds and the STI ETF for my example.

To do this, you usually have a bond portion and a stock portion.

For example, let's say I only want to use $10,000 as investment capital, how do I go about doing this?

The first step is to work backwards to find out how much bonds you need to guarantee that their yield will be equal to the capital amount invested.

I did the math for you. If you use $8,000 to buy FCL bonds, after 7 years of collecting $292 of interest payments a year and socking it at 0% interest, your total value of interest collected and capital returned will be $10,044. This is the part that "guarantees" your capital.

With the balance of the $10,000, you have $2,000 which you can gamble with and put in stocks. I would do it the POSB Invest-Saver for a one month lump sum of $2,000 and select the option to re-invest my dividends. Hassle-free yo. Based on the long term average, perhaps we can expect stocks to go up 8% a year, which would grow the $2,000 to become $3,427. Now add that back to the bond portion and we get projected final value of our "structured deposit" to be $13,471. That gives you a projected total return of 34.8% or annualized returns of 4.3%. Not bad considering you CANNOT lose more than your initial capital, eh?

If stocks end up shitfaced and suffer a 40% drawdown and never recover, our stock portion actually shrinks from our initial $2,000 to only $1,200. Add the bond portion to get a final value of $11,244, which is total returns of 11.2% that translates to annual returns of 1.7%. That's not too horrible considering that stocks got raped. Working out this downside risk is the "guaranteed" returns part, since the stock portion won't go to zero. It would still be worth something.

I think people fall in love too much with structured deposits, especially if they are capital guaranteed. It isn't that hard to create a product like that.

Now, look at UOB's current structured deposit offer. 6 year period. Capital guarantee of 11% total returns. Max upside of 13%, WTF.

CIMB's offer seems even worse. 5 year period. Capital guarantee of 9.4%. No talk of upside or projected returns. WTF.

DBS, OCBC and StanChart are smart enough not to put their structured deposits online, or I will criticize the shit out of it. If you are smart enough to notice the trend, their products would also evoke a WTF reaction. A negative WTF, not a positive WTF.

Now, you can go run along to one of the banks or insurance companies and get one of those structured deposits or endowment policies and get returns 2% a year, or you can make your own with a "capital guarantee" and a "returns guarantee" of 1.7% pa. But in this case, the upside is much higher, at 4.3%.

One of the biggest misconceptions of structured deposits and endowments plans are that the banks or the insurance companies magically conjure up the money to pay investors. That is completely untrue. Almost every product is created similarly to this. Even before you buy the product, they know they will not lose money on it. For endowment plans, they will use a portion of the returns to purchase a cheap term insurance over the period of investment, which is why there is always some small insurance portion to it. But it is so small. To insure a life for the capital amount will put on drag on returns by less than 0.5% a year. For young people, it's closer to 0.15% a year. Over 7 years? A 1% drag on total returns.

So, the expected returns of your own DIY structured deposit is 4.3% annualized over 7 years if the stock market continues it's long term path, and worse case scenario looks to be 1.7% annualized. Perhaps I should open up a bank and offer a flat 1.7% guarantee with a "performance bonus" that all the banks like to call it, of maybe an extra 3% in the final year. That means if all goes as expected, I can collect 34.8%, I would only payout to investors 14.2% and I would pocket the difference of almost 20%! If the world turns to shit, I just payout whatever I collected. I am in a riskless position. I either make money, or I don't lose any money.

This is a classic example of doing it yourself and getting the best deal, as opposed to asking someone else to do it for you and you get screwed over by them.

So, that is it for structured deposits and endowment plans. Good for you, or good for the company that you are buying from?


  1. Hey bro now we can re-invest our dividends in POSB Invest Saver?

    1. Hi Anon,

      Post regarding that should be up tomorrow, but short answer: It seems so!


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