7.45% Guaranteed vs VTI

[YoungAndNotFree]

Hello,
I will try to be as straight forward as I can.

I live in a Latin American country, and our central bank which has been very trustworthy for the last 40+ years. Is offering basically national bonds in US currency with a yield of 7.45% bi-annually payout for 20 years time frame (tax free).

I know I can get on average more than that on VTI, also its tax free (on capital gains) since I’m a foreign investor.

However the consistent cash flow (tax free, risk free) is becoming very tempting. I would like you thoughts on this and if you can provide input if you would take this deal.

On major driver of this consideration is I’m planning on leaving my full time job next January, and this bonds would provide a consistent cash flow for me and my family.

Thanks in advance.

[maizefolk]

Are you in a country that uses the US dollar as the official currency (like Panama, Ecuador, or El Salvador)? Or is there a local currency but your central bank is issuing USD denominated debt?

In the first case I'd be curious how your local inflation in USD terms compares to the USD inflations we are seeing here in the states. If your inflation matches ours (possible since we're talking a common currency) currently at 8.3%/year, 7.45%/year would actually be a negative real (inflation adjusted) return.

[secondcor521]

It's not risk free.  Regardless of its past history, your country's government is facing some sort of risk of default (or possibly high inflation?) if they're paying that sort of rate.

[YoungAndNotFree]

We have a local currency which is pesos, historical average inflation in our local currency of 6%. And a devaluation rate historically of 2%-3% against the US dollar.

So basically in USD I would be protected against devaluation.

[maizefolk]

Deleted this post. I was reading exchange rates wrong.

[secondcor521]

We have a local currency which is pesos, historical average inflation in our local currency of 6%. And a devaluation rate historically of 2%-3% against the US dollar.

So basically in USD I would be protected against devaluation.

I would wonder why your government issuing debt in USD instead of pesos.  Also, the protection you're seeking relies on the exchange rate later, and possibly also the exchange rate now depending on where you're getting the funds to invest.  If the exchange rate moves the wrong way, that's another risk to consider.

[Radagast]

I would be careful with "7.45% Guaranteed." As a general investing rule the risk of an investment, especially a bond investment, can be judged by its return. At 7.45% there is probably a hidden risk there somewhere.

So my motto applies: "when in doubt, do both." If you plan to spend mostly in pesos then it makes sense to own those. You also get growth from VTI. Also by the way if you are not in the US I think VT (total world) would be a better choice than VTI. People don't remember, but the US stock market has not always been "the place to be", and I expect at times in the future it will also not be that place.

[MustacheAndaHalf]

I live in a Latin American country, and our central bank which has been very trustworthy for the last 40+ years. Is offering basically national bonds in US currency with a yield of 7.45% bi-annually payout for 20 years time frame (tax free).
...
On major driver of this consideration is I’m planning on leaving my full time job next January, and this bonds would provide a consistent cash flow for me and my family.

When I say surging oil prices, high inflation and slower growth worldwide, do you think of 2022?  Or 40 years ago?  Because that time frame you mention, 40 years, starts after the last time Latin America had a big debt crisis.
https://en.wikipedia.org/wiki/Latin_American_debt_crisis

Given the risk factors of the bond (emerging markets, high yield, long term) and current conditions (rapidly rising inflation, slowing growth), a number of bonds like this one should default as things get worse.  I don't know if this one will result in a total loss, but I think you're ignoring the risk: you could wind up with nothing.

[YoungAndNotFree]

Thank for all the replies.

I know the inherent risks associated with my country and the Emerging Market landscape.
Unfortunately this is where my business is, and most of my everyday economic activities.

I was approaching the question strictly to the performance % wise.

Would you sacrifice the volatility of the markets (which is my main investments ATM) and settle for a 7.45% “with some sort” of stability generating cash flow?

[ROF Expat]

So, how high are the "inherent risks" in your country?  How do Moody's Fitch, and S&P rate your government's debt?  If they view it as investment grade, I wouldn't worry too much about default.  If they characterize it as less than investment grade, I would be very cautious.  Being denominated in dollars protects you against exchange rate losses (at the expense of losing the upside if the dollar declines against your currency).  BTW, the fact that the government is offering a dollar bond indicates that at least some investors are concerned about exchange rate risks.  How much is the difference between the interest rates of the Government's dollar and local currency bonds?  The difference should tell you something about how other investors measure that exchange rate risk. 

The real risk is that inflation overtakes that 7.45% interest rate over the next 20 years.  Of course, buying bonds might be particularly profitable if you are a contrarian and believe that inflation will be tamed and interest rates will be dropping.  That said, with a historical average of 6% inflation in your country and the global economy potentially entering an inflationary period, 7.45% doesn't seem compelling to me. 

I have no opinion on VTI.  A lot would depend on your specific circumstances and what the rest of your portfolio looks like, but I would question buying stocks if you really need this money to produce "consistent cash flow" as you stated in the original post.  Personally, if I were in your shoes and needed to rely on cash flow from this investment, I would be looking for alternatives beyond US/global stock markets and a long-term bond.  Maybe rental real estate, for example, but that will be dependent on your specific market. 

[YoungAndNotFree]

So, how high are the "inherent risks" in your country?  How do Moody's Fitch, and S&P rate your government's debt?  If they view it as investment grade, I wouldn't worry too much about default.  If they characterize it as less than investment grade, I would be very cautious.  Being denominated in dollars protects you against exchange rate losses (at the expense of losing the upside if the dollar declines against your currency).  BTW, the fact that the government is offering a dollar bond indicates that at least some investors are concerned about exchange rate risks.  How much is the difference between the interest rates of the Government's dollar and local currency bonds?  The difference should tell you something about how other investors measure that exchange rate risk. 

The real risk is that inflation overtakes that 7.45% interest rate over the next 20 years.  Of course, buying bonds might be particularly profitable if you are a contrarian and believe that inflation will be tamed and interest rates will be dropping.  That said, with a historical average of 6% inflation in your country and the global economy potentially entering an inflationary period, 7.45% doesn't seem compelling to me. 

I have no opinion on VTI.  A lot would depend on your specific circumstances and what the rest of your portfolio looks like, but I would question buying stocks if you really need this money to produce "consistent cash flow" as you stated in the original post.  Personally, if I were in your shoes and needed to rely on cash flow from this investment, I would be looking for alternatives beyond US/global stock markets and a long-term bond.  Maybe rental real estate, for example, but that will be dependent on your specific market.

We are the 7th LATAM economy and the largest in Central American and Caribbean, given our reality (developing country) we have a very stable economy.
Thanks for the input, and yes we do own (1) rental property which produces good income, however market is booming here also, and properties are very expensive (I wont take debt on it).
The minimun bond offer starts at US$1,000 so basically I was planning on diverting US$1,000 to US$2,000 to the bond proposition for cashflow in the upcoming years (after 2023 when I leave my normal job).

Having read all the opinions, and based on my own criteria, I think I will split 50%/50% VTI investment and the cashflow bond for some time.

Thanks all of you for your input, and the perspective. I really appreciate it.

[ChpBstrd]

One perspective I haven't heard is geographic diversification.

Suppose a major economic crisis hits your country for whatever reason. If you're heavily allocated to your own country's dollar bonds, then the value of your bonds will go down at the same time as your business / rentals suffer, which will all occur at the same time when it is very difficult to get a job. You would prefer for the bonds to be a backup plan - a stable source of income for when the economy goes bad.

There are US-based high-yield bonds and preferred stocks paying around 6%. They too might default, but unless we have a global depression it will be for different reasons, and perhaps with different timing, than when a particular Latin American country's sovereign dollar bonds could become distressed.

In hindsight, the best way a person in Argentina could have navigated their latest crisis would have been to buy dollar-denominated bonds from outside the country. Those with all their eggs in one basket were hurt the most.

[YoungAndNotFree]

One perspective I haven't heard is geographic diversification.

Suppose a major economic crisis hits your country for whatever reason. If you're heavily allocated to your own country's dollar bonds, then the value of your bonds will go down at the same time as your business / rentals suffer, which will all occur at the same time when it is very difficult to get a job. You would prefer for the bonds to be a backup plan - a stable source of income for when the economy goes bad.

There are US-based high-yield bonds and preferred stocks paying around 6%. They too might default, but unless we have a global depression it will be for different reasons, and perhaps with different timing, than when a particular Latin American country's sovereign dollar bonds could become distressed.

In hindsight, the best way a person in Argentina could have navigated their latest crisis would have been to buy dollar-denominated bonds from outside the country. Those with all their eggs in one basket were hurt the most.

Totally agree with you. Would you point out high yielding instrument in the US stock? I usually track REITs and some CEFs. They had been hit hard on this downturn, but would like to know what else are you referring to.

One downturn specifically for me is I get a 30% tax rate on dividends as a foreing investor, so any % yield is taxed on 1 third.

Thanks in advance.