Should you Invest in T bills at 4%?

  

The Cut Off  Yield for November T Bills is at 4%,

This is a drop from 4.19% before. Despite the increase in FOMC rates and the 3 Months MAS T-bills, it was surprising to see a drop instead of an increase.

However, due to the sheer size of this month's bid (Over 14 billion vs 4.5 billion), the results was affected by the increase in demand.

How did it happen?

The T-bills bids are separated into 2 bids, Competitive and Non Competitive Bids; there is a likelihood that Competitive Bids were the main reason why rates fell. This can be seen when we compare the results of the previous issue. In the last round, 14 % of competitive applications were allocated. This time the cut-off was at  64%. This implies that 64% had bid at a rate of 4% or less.

As T-bills have been under the radar for a long while, institutions tend to be the bidders; hence, the interest rates are close to market expectations. However, with the sudden demand and the emergence of retail investors putting in Competitive low bids (some as low as 0.1%), the results are skewed to the lower range. At 4% interest, it is only a tad higher than Fixed Deposit rates, which are hovering near 3.7-3.9%

INVEST OR NOT?

With the oversized demand for T-bills, interest rates might hover or even fall below 4%. This begs the question. Is it still worth it to invest in T-Bills?

Opportunity Cost : Actual Return is less than 4%

T-bills can be invested using Cash, SRS or CPF. The actual rate of returns is less than 4% for the following reasons.

CPF 

If CPF is used, the month where CPF is deducted will result in a loss of interest. For example, for this T-bill, you will lose interest for Nov, despite the T-bills starting on 15 Nov. Similarly, when T Bills is credited into your account on May when it matures on 16 May, you will not earn the interest on the remaining month of May.

Here is an example

Interest earned: 4% pa or 2 % nett
Interest lost via CPF: 0.204%
Net interest: 1.792% or 3.584% pa
Net gain:  1.792% -1.25% = 0.542% or $54.2 for every $10,000 invested

While it is still higher than CPF rates, there are other costs. To open a CPF-IS account and application, you must personally apply at the branch. There is a wait time of 2-3 hours per visit. If you invest only $10,000, you will gain only $54.2. Would this makeup for 6 hours in the bank and the cost of transportation to and fro?

For the next issue on 17 Nov, the interest rate earned will be lesser due to the dates of the t-bills. You could potentially lose 2 months' interest. 

Assuming a 4% return, this is what you can get

Interest earned: 4% or 2% nett
Interest lost via CPF: 0.204% x2 = 0.408%
Net Interest: 1.592% or 3.184% pa
Net gain: 1.592%- 1.25%= 0.342% or $34.20 for every $10,000 invested

As you can see, the returns are insignificant if the invested amount is smaller

Cash

While investing using CPF for a bigger amount may be viable, the same cannot be said for Cash. Currently, for Cash, you can get rates up to 3.9% for 18 months fixed deposit for 10,000. While the tenure is longer, you need not worry about investment risk and loss of interest due to the dates required to debit/credit for t-bills.

 FOMO The next auction could be lower

With the headlines screaming overwhelming demand for T-bills, it will naturally perk the interest in this. As a result, we anticipate that the next few T-bills will be oversubscribed, and the scenario will repeat itself. The CPI for the US was also reported to be lower, mitigating the risk of large interest rate movement. Thus, if you are parking your funds for the next T-bills, you might lose potential interest earned.

Investment Risks

The T-bills are offered in 6-month and 1year time frames. For the rest of the year, only 6 months T bills are available. This means the interest offered may change at the end of the 6 months. It may be higher or lower. If lower, the current FD rates will be more attractive over a 1-year timeframe.

Cost of missing the T bills

If you had missed a T bill, you would have lost 2 weeks of potential interest. That means for every $100,000 you set aside for T-bills, you would lose $154 each time you miss an allocation.

Illiquid T-Bills 

Among the safe assets, T-bills are the most illiquid. While you can sell, you would have to head down to the bank to do so. Moreover, finding a market maker might be challenging, and you might lose the principal. Thus, the funds you are investing should be earmarked for long-term use.

What to DO to protect your downside

Use competitive bid

If you are placing CPF funds, placing a Competitive bid instead of a non Competitive Bid is advisable. Set aside a minimum bid that will make sense to utilise CPF funds. Otherwise, in a black swan event, you might end up with a rate lesser than what CPF is giving.

Also, for a Non-competitive bid, you might not get a full allocation. This will result in opportunity costs for the funds not invested.

Do not abuse the Competitive Bid

There had been strategies in some investment forums to place 0.1% competitive bids to get a full allocation. While this may get you the full allocation, it will also bring down the cutoff yield as it is based on the overall competitive bids. It is similar to a Prisoner's Dilemma. For new investors, this is usually the case and thus explains why the last T-bills closed at a 4% cut-off yield.

Do not put all your eggs in one basket.

Last but not least, diversify your portfolio. Do not place all the eggs into one basket. Consider alternatives such as Fix Deposit and Singapore Savings Bonds. This will help soothe the fluctuations of interest rates over time and make your returns less unpredictable in the long run.

Disclaimer
The information provided by TWD serves is for educational purposes. It is not meant to be personalised investment advice. Readers must do their due diligence and refer to financial advisors for their investment needs. The information is correct as of 28 Oct.