Can you generate $3125 a month income by investing in low risk cash or bonds? (on $1.2 million portfolio)

So I received this really interesting question:

Hi boss FH, I need your financial view and opinion on the safe return for a sum of $1.2 million cash if I liquidate my fully paid condo.

I am a retiree in my 70s. My LH condo lease balance is 61 years, and is about 300m away from mrt. Twice, attempts for en-bloc failed at 75% and 72%, respectively. Lately, my tenant has given me a lot of problems, and I have vacated him.

Some numbers here.

Floor area 1152 sq ft (2bedders, 2bathe rm) say at $1085 $psf

Realistic selling price, $1.25 million

Realistic Rental say $3k per mth after less all expenses aro $726, net rent collected is aro $2274 per mth ($27.29k pa), translated to about 2.18% return

If my $1.25 million cash can get 3% return (very low risk) which is $37.5k pa and $3,125 per mth, wow this is good cos no tax no headache.

But the question is am I able to get a very low-risk 3% return in mid & long term, nowadays Tbill and FD rates keep dropping non-stop.

Yes, if I sell will not enjoy the property appreciation in the future, this one I have already factored in the lease decay problem but if enbloc then I LL, cos enbloc premium is aro $180k more than my current selling price, 

In short, is my 3% (very low risk) target feasible in mid/long term, oh yes CPF and SSB is out cos I had reached the max cap,,, stocks is out for me. Currently, GXS, Maria, Trust and  some high saving bank acc, ..etc are giving aro 3%, but need to follow up closely, transfer HERE & THERE, abit busy…..

Can you generate 3% return on cash for the mid to long term?

Okay.

So fundamentally, the question is this.

With $1.25 million in cash.

Can you invest that in a low risk investment, that returns 3%ish for the mid to longer term.

What is the mid to long term?

Given the retiree is in his 70s, I would say ideally you want to keep this up for 5 – 10 years at least.

Then after that, if you have to draw down a little bit of the principal, it’s probably not the end of the world.

So to reframe the question.

If I gave you $1.25 million tomorrow.

Are you confident of generating a 3% yield for the next 5 – 10 years, only using low risk investments, and no:

1. CPF
2. Singapore Savings Bonds
3. Stocks
4. REITs

What is the biggest risk?

In my view there are 2 key risks:

1. Interest rates go down
2. Inflation goes up (and short term interest rates do not go up by enough)

Interest rates go down

The Feds are projected to cut interest rates 3 times over the next 12 months.

But remember the time frame we are looking at is 5 – 10 years.

And if you keep buying 6-month T-Bills over the next 5 – 10 years.

You’re just going to be absolutely at the mercy of short term interest rates.

If rates go up to 4% on T-Bills you live like a king with $4000+ a month.

If rates drop to 2% you live like a pauper on $2000+ a month.

If worst case rates drop to 1% then well you’re going to get really anxious.

And do I know where short term interest rates will go over the next 5 – 10 years?

Boy… absolutely no clue.

If I am right, then this is a decade of structurally higher inflation and interest rate volatility.

In which case short term interest rate may bounce all over the place for years.

How to solve this?

To solve this – you want to extend your duration.

Instead of just buying 6 month T-Bills, you want to mix in some bonds that can last a few years at least.

This gives you some protection even if short term interest rates go down, as technically you have “locked in” the interest rates.

But of course the drawback with higher duration is that this means mark to market losses if interest rates go up.

But I suppose if you’re holding for the yield, this isn’t so much of a problem.

Inflation goes up (and short term interest rates do not go up by enough)

The other risk is a bit more insidious.

Imagine that inflation runs at 4% the next few years.

And yet T-Bills continue to yield 3%.

Everything may look fine and dandy.

But in 5 years time, suddenly the price of everything has gone up significantly, and suddenly the $3000 no longer buys you the same quality of life.

If I am right – I actually think this is the bigger risk this decade, and a key risk for investors to watch out for.

As the reader himself pointed out – holding onto property helps to address this in a way, because the rental rate and property value may be able to keep pace with inflation.

If you hold cash/bonds and you’re stuck at a 3% yield, that’s a much lower buffer against inflation.

How to solve this?

Solving this is a lot more tricky.

Because the solution is usually to buy inflation hedges – Stocks, real estate, Bitcoin, gold, commodities etc.

But the investor has clearly said that these instruments are out of bounds because of risk exposure.

In which case I would say you want to aim for a slightly higher target yield of perhaps 3.5% – 4.0%, to provide some buffer.

But then again this entails higher risk, which the investor is not comfortable with.

I suppose the question comes back to this.

If the money stays in real estate, it’s not like it’s risk free as well – rentals could go down, prices could go down, not to mention all the expenses.

So if one sells the real estate and frees up $1.25 million, maybe some risk on that cash is acceptable as well?

Ultimately – a question for the investor himself to answer.

What are the options to park cash?

At a high level, these are the options available:

12. Short Duration (<12 months)
    1. T-Bills
    2. Government Bonds
    3. Fixed Deposit
13. Longer duration (2 – 4 years)
    1. Bond Funds
    2. Buy individual bonds (retail / accredited investor)

Short Duration (<12 months)

The short duration bucket is generally low risk and should not be controversial.

We’ve talked about T-Bills / Fixed Deposits to death so I will not belabour the point.

Longer duration (2 – 4 years)

The longer duration bucket though, gets a bit more tricky.

Buying individual bonds are tricky because you need to evaluate the credit risk of the issuer. 

And there were a lot of people who thought Hyflux or Credit Suisse bonds were safe – and look how that turned out.

And if you diversify via a bond fund.

You can realistically get a 4-5% yield for somewhat low risk in today’s market, hedged back to SGD.

But I’ve written a lot of articles on bond funds in the past, and they are a somewhat complex product in that you need to watch out:

1. Interest rate risk  – you can suffer capital losses if rates go up
2. FX risk – pick SGD hedged always
3. Default risk – make sure you only invest in low risk investment grade bonds

Are these too risky?

Again, for each investor to answer for themselves.

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Best and worst case scenarios?

Let’s run some scenarios.

Let’s say you put 50% into a 2 – 4 year duration bond fund today, that yields about 5.5%.

And the rest into cash at 3.0%.

That’s a monthly income of $4400.

Good stuff.

If interest rates go down.

The bond component yields 4%

The cash yields 2%.

That’s still $3125 a month.

Still acceptable.

What if interest rates fall further?

The bonds yield 3%.

The cash yields 1.5%.

Then that’s only $2300 a month and well below target.

Not so great.

What is my view? Can you generate 3% returns in the mid to longer term?

My personal view?

I think you *should* be able to generate 3% returns on cash this decade, for the simple reason that this decade is one of higher structural inflation / interest rates.

Market today is pricing in significantly less interest rate cuts from the Feds, and a terminal rates of about 3.75% (for US rates).

Of course, if there is a recession in the next 5 – 10 years, and the Feds cut short term interest rates, then rates will come down which is why you need the exposure to the longer duration bond component.

But actually my biggest concern would be that the 3% will not be sufficient to keep pace with inflation.

And there I have no easy answers – other than to aim for a higher yield (while keeping within your risk appetite).

What if you’re not comfortable with bond funds?

And note that the instruments I am using above – half of them are actually bond funds.

If you’re not comfortable with bond funds? Or think they are too high risk?

Another option to lock in duration is to buy Singapore 10 year government bonds.

These currently yield 2.95%, so you’re pretty much guaranteed a 2.95% yield until maturity.

The problem is that I’m not a big fan of buying 10 year government bonds at a 2.95%.

If interest rates go up, you’ll be sitting on hefty mark to market losses.

And it’s not like the 2.95% yield is that amazing to justify locking it in for 10 years (whereas if it goes to 3.5% – 4.0% then okay maybe it’s a different story).

So I’m not really a fan of 10 year bonds here, and if you really want to go down this path I would say use the 5 year government bonds instead.

These also yield 2.86%, for significantly lower duration. 

But with this approach the yield on the bond component is much lower – giving you much less flexibility if things head south.

So personally I prefer using the bond funds approach, but no doubt this has to go back to investor risk appetite.

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