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Investing in bonds

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Unlike many countries, Singapore does not need to rely on the issuance of government bonds to finance its expenditure as it operates on very prudent budget. However, in light of the 1997’s Asia Financial Crisis, the Singapore government saw the need to develop the market for bonds so as to meet the banks’ needs for risk-free asset in their portfolio.

One of SG Wealth Builder’s blog missions is wealth preservation and therefore, investing in bonds has always been on my mind. But is investing in bonds suitable for everyone? To answer this question, it depends on which phase of your life you are currently in and the kind of returns you are expecting from your investments.

Generally, for those who are in the twilight stage of their wealth building journey or planning for retirement, bonds offer a source of regular fixed income stream and opportunities for capital gain. But this is not to say that such instrument is safe and of low risk nature. There are certain risks that investors must watch out.

To highlight the risks, many investors were stunned by Swiber Holdings Limited’s swift collapse in 2016. It is unknown whether Swiber bondholders can get back any of their investments.

Bonds

Default risks

A bond is a form of debt security in which you lend money to the bond issuer. In exchange for your loan, the bond issuer would pay you regular stream of income in the form of coupon. Coupon rate is a percentage of the principal amount, which is also known as the “face” or “par” value. Upon maturity, bonds are redeemed at the face or par value.

Broadly speaking, there are two types of bonds – government and corporate. The former usually come with higher quality credit ratings while the latter are of lower credit ratings and come with higher risks. Thus, investors must ask themselves the level of risks they are willing to accept. Higher risks come with higher returns (higher coupon rates). As a result, many government bonds are assigned investment grades while corporate bonds categorized as “junk bonds” that offer high coupon rates but carry higher default or other credit risks.

Like all investment products, you can lose part or even all your capital. This is especially so when the economy is not doing well and the issuer defaults on the bond. When this happens, the issuer may not be able to make interest payments or repay the original investment amount to the bondholder upon maturity. So never assume that all bonds are safe investments!

Interest rate risks

One of the biggest risks affecting bond investments is the interest rate risk. Market interest rates and bond price always move in opposite directions. In addition, the yield is inversely related to the bond price. This means that an increase in the market interest rate will cause the bond price to fall and led to an increase in yield for anyone who buys the bond at the lower bond price.

Hence, you need to monitor the global economic situation closely because the events may affect the issuer and indirectly impact your investments. For example, if bond price falls, you would suffer from capital loss if you sell the bond prematurely.

So, is it the right time to invest in bonds now? In my opinion, under the current low interest rate environment, buying bonds would be an interesting opportunity because the United States Federal Reserves are starting to raise interest rates in view of the improving job market. This means that bond prices may soften and yield could go upwards.

Liquidity and market risks

Bond is a type of fixed income debt instrument that issues coupon to holders. Therefore, most bonds cannot be redeemed before maturity. You may, however, sell the bond before it matures to the secondary market. However, callable bonds have a feature which gives the issuer an option to redeem the bond before its maturity date. The issuer may specify a price at which it will call (or redeem) the bonds.

Liquidity risks will affect you if you decided to sell the bond before it matures. As the bond price is impacted by interest rates, you will face liquidity risks due to market conditions. Hence, investing in bonds require a certain amount of holding power. If you are forced to sell your bonds before maturity because of changing personal financial situations, you may incur capital losses.

Furthermore, if the investment bond you are holding on does not have interested buyers, it means that the bond is not liquid.  Due to this risk, bond issuers compensate holders by offering longer maturity with higher coupon rates.

In Singapore, investors can buy Singapore Government Securities (SGS) bonds that are issued and backed by the Singapore Government. The Singapore Government does not need to finance its expenditures through the issuance of bonds as it operates a balanced budget policy and often enjoys budget surpluses. Hence, SGS are considered among the safest possible investment instruments to hold and have been consistently been accorded triple A rating by many credit agencies like S&P and Fitch.

SGS also issues Treasury bills (T-Bills) which are short-term debt securities that mature in on year or less. T-bills are sold at a discount to the par value and when they mature, the Government will pay the holder the par value. Hence, the interest earned is the between the purchase price and the par value. Essentially, T-bill works like a zero-coupon bond and is traded at a rate of discount basis.

For many years, Singapore government enjoys very strong credit ratings with minimal risk of defaulting from various international credit ratings agencies. The long-term local and foreign currency debt ratings of the Singapore Government accorded by the various international credit rating agencies are listed below:

    Moody’s S&P Fitch R&I
 Local Currency Aaa AAA AAA AAA
 Foreign Currency Aaa AAA AAA AAA

Source: www.sgs.gov.sg

However, on the other hand, corporate bonds are considered riskier because they are more likely to default on coupon payments, especially during financial crisis. Moreover, some corporate bond issuers may redeem their bonds before maturity at conditions unfavourable to you. So, you need to read the term and conditions carefully before investing in bonds.

The key reasons for buying bonds are primarily for interest income and capital gains. By purchasing bonds, investors’ total returns consist of regular income through coupon payments and capital gains if the bonds are sold at higher price than the price bought. Thus, even though the coupon rate is fixed throughout the life of the bonds, the bond price may vary and affect your investments.  Of course you may hold the bonds to maturity. In doing so, you will be repaid the principal amount of the bond at maturity, provided the bond issuer does not default.

You may choose to sell your bonds before maturity in the secondary market, provided there are buyers. The price that you would receive depends on the prevailing market condition. If you sell the bonds at prices higher than you bought, you made capital gains. There are opportunity costs in holding bonds. Therefore, sometimes it makes sense for bond holders to sell before maturity if the price is good.

Do you invest in any bonds? If so, hope you can share your experience in this blog. Join me in my wealth building journey by subscribing to the free email notification.

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Magically yours,

SG Wealth Builder

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Updated: September 19, 2017 — 2:37 pm

2 Comments

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  1. i believe bond is not suitable for general public; as the return is low and entry barrier is high, retail investor gets little benefits to invest in bond unless the counter is leveraged; but if leveraged ever, it is not retail game

  2. Hi Bruce,

    To a certain extent, I agree with you. My purpose of writing this article is actually to share the differences between corporate bonds and government bonds. But as I research more about bonds, I realize investing in this type of financial is not as simple as I thought it would be. There are so many things to consider that my affect the return.

    Regards,
    Gerald
    http://www.sgwealthbuilder.com

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