You know it, the stock markets have reached an all-time high. If you are like most investors, you probably feel a bit jittery about this. Will there be a market crash soon? If you do not invest in stocks, where can you put your money?
Today I will talk about bond investments, the stable source of return for many high net worth individuals and institutional investors.
What makes a bond investment?
If you are not familiar with bond investments, it is a type of debt instrument.
Most likely you are familiar with borrowing money from the bank to finance your housing loan. The company, which is the bank in this case, gives you the money and you will pay back the loan plus the interest over the years.
A bond investment is the other way around. You lend your money to a company or a government (the bond issuer) and they will pay you the interest and return the money you lend when the bond “matures”.
For example, when you buy a Singapore Savings Bond, you are essentially lending your money to the Singapore government.
Why should you invest in bonds?
Bonds are known as “fixed income securities” because most bonds pay a steady stream of interest income at periodic intervals throughout the life of the bond.
You will want to invest in bonds for two main reasons, capital preservation and income.
Capital preservation: Unlike equities, bonds repay your investment principal at a specified date (like your mortgage loan tenure). This makes bonds appealing if you do not want to risk losing capital. Bonds also have the benefit of offering interest at a set rate that is often higher than your bank savings rates.
Income: Most bonds provide you with “fixed” income. On a set schedule, whether quarterly, twice a year or annually, the bond issuer sends the bondholder an interest payment. Although stocks can also provide income through dividend payments, dividends tend to be smaller than bond interest payments. Moreover, companies make dividend payments at their discretion, while bond issuers are obligated to make interest payments to you.
Why does a government or company issue bonds?
The next question you may ask is, “Why does the government want to borrow money from you?”
More often than not, the government needs money to build infrastructure. For example, if the HDB wants to build some new flats and it takes 5 years to build and sell the house, they will want to borrow your money to pay the developers first instead of dipping into their reserves.
Because of the reputation and stability of HDBs, they can raise the money at a very low cost. The 5-year bond issued by HDB in Feb 2017 only needed to pay a coupon of 2.2325%.
At the same time, the property developer can also issue a bond to fund their development costs such as materials and labours. But as they are not as credible as the HDB, they have to a pay a higher interest to you such as 5%.
What does a bond look like?
Technically, the bond interest is called a coupon and the term is called tenure. To help you understand this, I have listed some of the SGD retails bonds available in Singapore below:
You can generally find the important information just from the bond names, for example:
- The bond issued by CapitaLand Mall Trust (SG3267000002) is offering a 3.08% coupon and the bond will mature on 20 Feb 2021
- The bond issued by Genting Singapore PLC (SG3257980320) is a perpetual bond (no expiry date) and the coupon is 5.125%. There is a “callable option” embedded into the bond. It means that Genting has the option to return all your principal in 2017. But I will not discuss the details and implication here.
As you can see, the bond typically offers much better coupon (interest) compared to your savings account or fixed deposits. If you will get back your money eventually, it is not a bad investment. So where is the catch?
The main risk of a bond investment
Like any investment products, there are risks involved in investing in bonds. If you look at the traditional asset class risk pyramid below, the government bonds and corporate bonds are considered low-risk investments (green layer).
This is understandable because as long as the issuer (the party whom you lend money to) is solvent, they are supposed to pay you back your principal.
But what if the issuer is not able to pay you back? What will happen then?
If someone wants to borrow money from you, most likely you will be very careful about who you lend it to, right? You should apply the same principle when you lend money to the bond issuers. Just because a company is big and reputable does not guarantee the safety of your money. The Swiber’s bond default last year teaches us a good lesson about this.
Therefore, I would say for most retail investors, it is best to start investing in a bond fund instead of a direct bond.
How to invest in bonds
I have given you some basic knowledge about investing in bonds.
If you are interested in finding out how to build a portfolio with stable income and capital preservation, you can contact me via this form below.