“Where, then, do we park our savings other than with the banks? The bond market gives us an alternative to bank deposits.”

My column last week talked about the basic features of our capital market. But what, in fact, is the relevance of the capital market to ordinary folks like us, anyway?
When we have some excess cash available that we set aside to save for a rainy day, other than locking it up in a drawer at home, we usually go to a bank to make a deposit to keep our money safe and to earn some interest.

The deposit can either be an ATM savings account or a time deposit. The ATM is the go-to for most of us because ATM machines are very accessible with hundreds of bank branches all over our country.

The problem, though, is that other than the convenience factor, we hardly earn any interest on our deposit, as explained in last week’s column.

With inflation rearing up its ugly head, particularly of late, this eats up whatever purchasing power we have in our savings.

If it’s a time deposit that you decide on, although you do earn a higher interest, you are required to leave your money with the bank for a fixed period of months or years. And if you need to withdraw before the agreed upon maturity, a penalty in the form of a significantly reduced interest on your deposit will be imposed by the bank. In basketball, it’s like a flagrant foul that is penalized by two free throws and ball possession to the opposing team!
Where, then, do we park our savings other than with the banks? The bond market gives us an alternative to bank deposits.

Last week I described the various fixed income products available in the market, which are basically GS, corporate bonds or LTNCDs. Each type of instrument has its own unique advantages and disadvantages.

The GS is clearly the most superior as far as safety of your investment is concerned. After all, if we can’t trust government, who else can we trust with our money? It’s like an unchallenged under-the-goal shot! A GS, however, gives you the lowest return pretty much like a free throw that counts only for a single point for every basket made.

A corporate bond, on the other hand, provides a more attractive return because, as I explained last week, since the possibility of a corporate bankruptcy is always present (although remote particularly for triple-A names), a higher borrowing rate compared to the government rate is expected.

For example, if the government is paying 4.85 percent for a three-year RTB, a corporate bond with the same maturity will probably pay an interest rate of about 6 percent.

Like the usual shots of the great outside shooter Kevin Durant, that’s a three-point shot!
An LTNCD, meanwhile, has the unique advantage of a tax-free interest rate for individual investors provided they hold on to the investment for at least five years. This means the rate quoted to you will not have any deduction.

An example is a recent five years and six months LTNCD issue of a top-tiered private bank, which has an interest rate of 4.5 percent. To make it comparable to other bonds that have a 20 percent deduction for withholding tax (because it is an LTNCD thus not subject to tax), an individual would effectively be enjoying an interest rate of 5.625 percent before taxes.

Important considerations

At the risk of being redundant with what I pointed out last week, I need to emphasize some important considerations for these bonds.

First of all, the banks do not guarantee these bonds! Since these are not deposits, neither is there a PDIC guarantee. Second, if you decide to unload your investment before the final maturity, there is a possibility you might erode your investment if the prevailing market interest rates when you sell are higher.

The flipside, of course, can happen when interest rates go down — you, in fact, will enjoy a premium if you decide to sell. The big banks usually manage their investment portfolio on this basis and can reap a huge trading windfall if they read the market trend correctly.

Big time trading losses, however, can occur when the treasury folks of banks misread the market. Not too long ago, if you recall, there was this massive trading hit on a government bank that resulted in a BSP investigation and some heads rolling.

How to choose

How, then, do we choose from these different product options available in the bond market?
There is no standard formula for determining what to invest in. It really depends ultimately on our individual limitations and objectives.

For example, if you are a very conservative investor, the bias would be to just buy GS, which is the safest bond instrument that is out there.

A good buy would have been the recent three-year RTB. But if the money you have available cannot be set aside for as long as three years, you can go for Treasury Bills for as short as 91 days, which at end May was at about 3.4 percent. Not bad compared to practically nothing in an ATM account.

Who can help

Who do we consult to help us make these investments?
All the big banks have a sales desk in their branches. The bank’s sales personnel are required by the BSP to be trained and licensed. The standard procedure is first an interview to assess the type of investor you are, i.e., conservative, moderate or aggressive. Banks are required to fill up a Client Suitability Profile for every investor of a capital market instrument. The profile depending on your responses to a standard Q&A is supposed to describe your investment preferences.
These investment preferences in turn trigger what they should offer you. You then sign off on the form to prove that they properly disclosed the nuances of the various investment products.
Next time you go to a bank to make an investment, make sure that this protocol is followed. You are entitled to this.
The BSP is very particular about financial education especially for the unsophisticated investors or the mom-and-pop type of investors.

Protection guarantees

How are our investments in securities protected?
The BSP requires Third Party Custodians to hold title, safekeep and and administer our securities, i.e., keeping track of the going market values and ensuring interest payments are monitored and paid to your account.
In addition, there is also a GS Registry of Scripless Securities (ROSS) operated by the Bureau of Treasury that serves as the official registry of the owners of the securities. In that way, owners are guaranteed that their GS purchases faithfully record their ownership.
Why are these measures needed? Lured by the promise of a high yield, investors can fall victims to financial scams. Indeed, sadly, there have been instances perpetrated by unscrupulous securities dealers that double-sell or even pass off a non-existent security to unsuspecting investors in search of a high interest rate. My personal take on this is that when what is being promised is too good to be true, it usually isn’t true!
Lest you conclude that investing in bonds is too complicated, next week I will talk about a popular and simple approach to investing.
As they say….abangan!