VLSx versus Global Track + cash

bowlhead99

Sailtheworld said:

123mat123 said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

Bonds are lower risk than cash

Well that's just not true. 

Government bonds I was thinking.

Still not true. (I) Bond yields are very low and can be negative - capital is at risk and (II) governments can default on their debts. 

Cash is nothing more than an IOU from the government so if they default it doesn't offer any protection.

Sovereign default ≠ a 'default' on cash in that currency. 

With bonds you are taking a double risk - (i) that the yield will be/stay >0% and (ii) the issuer will not default.

With cash there is only (ii) and even that is subject to the important distinction I mentioned above. Thus, your initial claim that "Bonds are lower risk than cash" is provably false.

Apples & oranges. When we're talking about risk we're talking about the risk of losing your deposit - not the risk of getting a lower yield so (i) is a red herring.

It's nailed on that when you buy a UK government bond you're going to get the principle back. If you have more than the compensation limits in cash it isn't - wouldn't any sensible person demand a higher yield for taking that risk?

If you have £100,000 and need to pay for an operation in 5 years time then you can buy a government bond and get that £100,000 back in 5 years - no other investment vehicle has such a cast iron guarantee. Such are the times we live in you may have to pay the government for this - that's the current price of safety.

Is that totally accurate ? If you buy bonds at issue and keep until redemption you get all your money (plus yield) back. If you buy at any other time the price fluctuates so you may get back more or less than you originally put in...?
I don't think bonds would be a good place for your "operation money" or have I missed something...

Yes the price fluctuates between purchase and redemption. If you have an absolute requirement for the nominal value of the gilt to be returned in 5 years then a gilt needs to be purchased with a maturity date in 5 years time. Buying, say, a 10 year bond introduces a risk that the value of the gilts in 5 years may be less than the nominal value.

But UK gilts with 5 year maturities for today will all cost more than £100, so even if you get 'the nominal value' of the gilt back, it's less than you paid.

For example a gilt maturing in June 2026 costs £109, and a gilt maturing in March 2025 (with a higher interest rate) costs £123.5 (plus spread). If you sell between now and maturity you may get more or less than you put in, and if you wait until maturity you will definitely get less than you put in - a capital loss is absolutely guaranteed. 

Meanwhile a savings account from NS&I or a FSCS protected bank account does not have a capital loss and may also pay higher interest rates, while carrying no practical risk of a loss due to default (within the compensation limits for banks, or unlimited for NS&I).

Sailtheworld

grumiofoundation said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

bogleboogle said:

Sailtheworld said:

Bonds are lower risk than cash

Well that's just not true. 

Government bonds I was thinking.

Still not true. (I) Bond yields are very low and can be negative - capital is at risk and (II) governments can default on their debts. 

Cash is nothing more than an IOU from the government so if they default it doesn't offer any protection.

Sovereign default ≠ a 'default' on cash in that currency. 

With bonds you are taking a double risk - (i) that the yield will be/stay >0% and (ii) the issuer will not default.

With cash there is only (ii) and even that is subject to the important distinction I mentioned above. Thus, your initial claim that "Bonds are lower risk than cash" is provably false.

Apples & oranges. When we're talking about risk we're talking about the risk of losing your deposit - not the risk of getting a lower yield so (i) is a red herring.

It's nailed on that when you buy a UK government bond you're going to get the principle back. If you have more than the compensation limits in cash it isn't - wouldn't any sensible person demand a higher yield for taking that risk?

If you have £100,000 and need to pay for an operation in 5 years time then you can buy a government bond and get that £100,000 back in 5 years - no other investment vehicle has such a cast iron guarantee. Such are the times we live in you may have to pay the government for this - that's the current price of safety.

Unfortunately your example doesn't support your argument - for £100000 you just stick it in 2 banks - no FSCS compensation limit issue. 

Or just put it in NSandI - backed by the treasury?

But since that currently pays 1.16% this is far more risky than government bonds- which are backed by....?

In the situation where the robustness of a government's guarantee was put to the test we don't know what would be prioritsed but we can make some informed guesses. It would all be a bit chaotic but as there's already a mechanism in place to pay six monthly coupons and principles coming due that would continue albeit it with newly 'printed' money. It's also signal to the outside world that the UK is still open for business.

Banks don't go bust routinely so it's a reasonable assumption that there would be a lag between a bank going bust and money being made available under the FSCS. Seven to 15 days is the aim but if we're really at the point where we're wondering who's top of the priority list then it's likely a number of banks have gone under and the FSCS would be inundated with claims. That's a liquidity risk more likely to be associated with people holding cash than gilts. There's probably more chance that local holders of cash in insolvent banks would be required to take a haircut - maybe you get back £8 for every £10 saved and a bit of a new currency which can only be spent locally every other Thursday called Patriotic Duty Dollars or somesuch. That goes for captive NS&I accounts too where you need to be a UK resident or have a UK bank account to hold one.

The risks are tiny but the FSCS isn't an invincible security blanket. You're getting a higher rate of return on cash to compensate you for the risk of your bank going bust, the increased liquidity risk, the risk of having to take a haircut and the risk of the government prioritising foreign owners of government debt.

If someone thinks you couldn't get a cigarette paper between the risk difference of gilts vs cash under the FSCS limit then I wonder why they aren't having street parties when they receive their 1.16% from NS&I vs 0% on gilts.

coyrls

You can't buy gilts at the issue price; they are auctioned and sell for higher than the issue price.

coyrls

Retail accounts are not open to institutions.  If an institution could put money in NS&I accounts as an alternative to gilts, they would do because the return is greater for the same risk.

bowlhead99

Sailtheworld said:

Banks don't go bust routinely so it's a reasonable assumption that there would be a lag between a bank going bust and money being made available under the FSCS. Seven to 15 days is the aim but if we're really at the point where we're wondering who's top of the priority list then it's likely a number of banks have gone under and the FSCS would be inundated with claims. That's a liquidity risk more likely to be associated with people holding cash than gilts.

As noted earlier, with gilts your ability to get your money back without too much unexpected capital loss is predicated on you holding it to maturity, which would generally be a lot longer than the 7-15 days of the bank account disruption, so I'm not sure the 'liquidity risk' for people choosing to use cash - rather than lock away for five years plus with a government bond - is a big deal (and there could be illiquidity in the gilt market in extreme conditions in any case) 

If someone thinks you couldn't get a cigarette paper between the risk difference of gilts vs cash under the FSCS limit then I wonder why they aren't having street parties when they receive their 1.16% from NS&I vs 0% on gilts.

The public at large are probably not really aware that the five year gilts are providing a negative return, because they don't generally participate directly in the gilt market due to not being a large institutional investor;  so they're unaware that they are getting a great deal out of NS&I and don't go and party. Instead on the savings forums people complain because the interest they are getting from their bank or NS&I at one to ten times the BoE base rate is not as much as they want, and they perceive the offered rates to be abhorrent - rather than a cause for street parties.

Their lack of understanding about general economic conditions doesn't mean that in practice such accounts are materially riskier than owning gilts or that the banks and NS&I offer an unattractive risk/reward ratio.

Sailtheworld

coyrls said:

You can't buy gilts at the issue price; they are auctioned and sell for higher than the issue price.

That's right - there's a cost associated with the increased security.

Sailtheworld

coyrls said:

Retail accounts are not open to institutions.  If an institution could put money in NS&I accounts as an alternative to gilts, they would do because the return is greater for the same risk.

Of course they're not open to institutions. The 'free lunch' of greater return & taxpayer guarantee is only open to residents or those with a UK bank account. There would be a scandal if the taxpayer were to provide insurance to institutions and provide a return at the same time. 

NS&I is another red herring when it comes to comparing risk. They have a mandate to encourage saving as well as provide a source of government borrowing - it's still only about 8% of the national debt though. It's vote buying to an extent (get other taxpayers to enhance security and return) rather than being indicative of whether cash is saver than gilts.

Sailtheworld

bowlhead99 said:

Sailtheworld said:

Banks don't go bust routinely so it's a reasonable assumption that there would be a lag between a bank going bust and money being made available under the FSCS. Seven to 15 days is the aim but if we're really at the point where we're wondering who's top of the priority list then it's likely a number of banks have gone under and the FSCS would be inundated with claims. That's a liquidity risk more likely to be associated with people holding cash than gilts.

As noted earlier, with gilts your ability to get your money back without too much unexpected capital loss is predicated on you holding it to maturity, which would generally be a lot longer than the 7-15 days of the bank account disruption, so I'm not sure the 'liquidity risk' for people choosing to use cash - rather than lock away for five years plus with a government bond - is a big deal (and there could be illiquidity in the gilt market in extreme conditions in any case) 

If someone thinks you couldn't get a cigarette paper between the risk difference of gilts vs cash under the FSCS limit then I wonder why they aren't having street parties when they receive their 1.16% from NS&I vs 0% on gilts.

The public at large are probably not really aware that the five year gilts are providing a negative return, because they don't generally participate directly in the gilt market due to not being a large institutional investor;  so they're unaware that they are getting a great deal out of NS&I and don't go and party. Instead on the savings forums people complain because the interest they are getting from their bank or NS&I at one to ten times the BoE base rate is not as much as they want, and they perceive the offered rates to be abhorrent - rather than a cause for street parties.

Their lack of understanding about general economic conditions doesn't mean that in practice such accounts are materially riskier than owning gilts or that the banks and NS&I offer an unattractive risk/reward ratio.

NS&I offer an attractive risk / reward ratio because, for whatever reason, small parts of the national debt are sold to UK residents at an interest premium with a guarantee - funded and backed by the taxpayer. It's not exactly chump change but it's a bit of arbitrage and has nothing to do with the wider question of whether gilts are safer than cash to which the answer is usually yes.

And, that's not to say that people with NS&I accounts are at the same risk level of non resident government debt holders. When the government really has to choose whether to shaft residents or foreign investors they'll choose residents because, no matter that they're struggling to meet their liabilities, they'll still want to borrow more.

masonic

Sailtheworld said:

And, that's not to say that people with NS&I accounts are at the same risk level of non resident government debt holders. When the government really has to choose whether to shaft residents or foreign investors they'll choose residents because, no matter that they're struggling to meet their liabilities, they'll still want to borrow more.

Usually the opposite argument is advanced. They'll prioritise their citizens, who can vote them out of government. That's what happened when the Icelandic banking system collapsed. Our present government seems to have little regard for its international reputation.

coyrls

Sailtheworld said:

coyrls said:

You can't buy gilts at the issue price; they are auctioned and sell for higher than the issue price.

That's right - there's a cost associated with the increased security.

So why did you say:

If you have £100,000 and need to pay for an operation in 5 years time then you can buy a government bond and get that £100,000 back in 5 years - no other investment vehicle has such a cast iron guarantee. Such are the times we live in you may have to pay the government for this - that's the current price of safety.

When it is not possible to get the £100,000 back in five years, as you would have had to pay more than the issue price.