Investing for 2 or 3 years? Look at the 5-year bond first
Buying a 5-year bond and redeeming it early is usually a better deal than buying the 2 or 3-year bond directly.
Taking interest monthly quietly changes the cost of leaving an RSB early. Once any RSB has been held for 12 months, it can be redeemed at the cost of one interest payment. Most investors take interest 6-monthly, so the cost is six months of interest. Any investor can instead elect to take interest monthly on a Fixed Rate bond — which means the redemption cost is just one month's interest.
This makes a counter-intuitive strategy work:
Buy the 5-year bond and redeem it after 2 or 3 years, instead of buying the 2 or 3-year bond directly.
Because the 5-year rate is consistently higher than the 2 and 3-year rates, the 5-year-redeemed-early structure pays more — even after the one-month forfeit.
A worked example
Treasury rates as at September 2017:
| Strategy | Term | RSB Rate | Effective Term | Effective Rate | Improvement | |---|---|---:|---|---:|---:| | Buy 2yr | 2 years | 7.50% | 5yr bond redeemed after 2yrs | 7.91% | +0.41% | | Buy 3yr | 3 years | 7.75% | 5yr bond redeemed after 3yrs | 8.02% | +0.27% | | (Reference) | 5 years | 8.25% | — | — | — |
Why? The 5-year rate is 8.25%, but you forfeit one month's interest as the redemption cost. Twenty-three months of interest at 8.25% then divides into the original capital and gives an effective rate of 7.91% over 24 months, which is 0.41% higher than the 2-year RSB.
The arithmetic in one line
Effective 3-year rate = (35 ÷ 36) × 5-year rate
So in the example: (35 ÷ 36) × 8.25 = 8.02%.
What the cash flows look like
For a R100 000 5-year bond at 8.25% redeemed after 2 years, versus the same R100 000 in a 2-year bond at 7.50%, both paying interest monthly:
| Date | 2-year bond (7.50%) | 5-year bond redeemed after 2 years (8.25% − 1 month penalty) | |---|---:|---:| | 2017-09-30 | 625.00 | 687.50 | | 2017-10-31 | 625.00 | 687.50 | | 2017-11-30 | 625.00 | 687.50 | | ⋮ | ⋮ | ⋮ | | 2019-07-31 | 625.00 | 687.50 | | 2019-08-31 | 625.00 | — (forfeited as redemption penalty) | | Total | R15 000 | R15 813 |
Total cash received from the 2-year bond is R15 000 — a flat 7.50% per year on R100 000.
Total cash received from the 5-year-redeemed-early structure is R15 812.50, or R7 906.25 per year — an effective annual rate of 7.91%.
Two further benefits
This strategy also gives you optionality at the redemption date:
- If rates have fallen by the time you reach two or three years, and you don't actually need the cash, you can stay invested at the original (now-higher-than-market) 5-year rate. You retain the option, you don't have to use it.
- If rates have risen, the Restart option lets you re-set into the new higher-rate environment.
The fine print
This strategy works only for bonds taking interest monthly. On 6-monthly interest you face a 6-month forfeit, which usually wipes out the rate uplift and makes the buy-and-redeem-early structure uneconomic.
Some older government pages still describe monthly interest as being for over-60s only. Treasury's current terms and FAQ say any investor can choose it.
The improvement over buying the 2 or 3-year bond directly varies as the term-spread of the curve changes. When the 5-year is well above the 2-year (a steep curve), the strategy works strongly. When the curve flattens or inverts, the gap closes — check current rates first.
See the Rates & Yields page for the current 2/3/5-year rates and historical curve.