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What are bonds and how do you buy them?
Diversify your investments with little risk by choosing bonds.
Instead, consider investing in bonds, where your money will be kept out of reach while it grows at a steady rate.
What are bonds?
A bond is a low-risk investment where you’re lending money to either the government or a company at a fixed interest rate for a predetermined period of time. You’ll receive interest payments on your investment on a regular basis, with the principal amount paid back to you at the end of the term.
Before deciding to invest in bonds, you should carefully compare your options, as some will pose more risk than others.
Case study: How do bonds work?
Edith has been transferring her spare cash into her savings account for the last two years, but is now starting to seriously think about her retirement. She decided to invest in a treasury bond, which will pay her interest twice a year on the investment. This is a low-risk option for her savings that will pay her the full investment back in 30 years when she’s closer to retirement.
By choosing a government-issued bond for her savings, Edith is able to diversify her investment portfolio while keeping a percentage of her money in her savings account where she can still add to the balance, earn interest and withdraw those funds as needed. The interest earned on her government bond will be added to this account, where it will then earn more interest.
Types of bonds
What is a coupon?
When it comes to bonds, you’ll see that the terms ‘coupon’ or ‘coupon rate’ are frequently used. A coupon or coupon payment refers to the annual interest rate paid on a bond, expressed as a percentage of the face value of the bond in question. Coupons are paid from the issue date until maturity.
You have a few different options when investing in bonds. Each choice has its own risk and return potential, making it important that you compare your options carefully before deciding on any one product:
There are three different types of government bonds that you can invest in, which are the treasury-bills (T-bills), Singapore Government Securities Bonds (SGS) and Singapore Savings Bonds (SSB).
These bonds are used to generate money for cash flow, financing debt, funding capital investments and more. In addition, these bonds are issued and backed by the Singapore government, rendering them risk-free but often have lower interest rates than other options.
This type of bond is usually a part of a public offer, where a company will issue a prospectus that informs consumers about the offering and allows them to make a direct investment. This is different from buying stocks, where you are a part-owner and your investment affected by the cash flow of the business.
With corporate bonds, you are a creditor and your return is limited only to the agreed-upon interest payments and the return of your principal investment. They usually offer better returns than government bonds, savings and fixed deposits but carry more risk — if the company fails, they may default on the debt.
Most corporate bonds being only traded on OTC markets, with some retail bonds that are listed on SGX. Also, note that not all bonds are available in small denominations or suitable for retail investors.
A Bond exchange-traded funds (ETF) is a pooled investment vehicle that holds a portfolio of bonds. It aims to track the performance of certain bonds or bond indices and tries to replicate the index performance through the use of derivative products like swaps.
The Bond ETFs can have different strategies.
Are bonds safe?
Government bonds are considered to be very safe, but there are bond options that can carry a high level of risk if you aren’t careful.
Bonds are typically less volatile than other types of investments, such as stocks, but it’s still possible to lose money with government-issued bonds. Bonds do come with a credit rating, but you will need to consult with a licensed financial advisor in order to access that type of information.
Pros and cons of bonds
Like any investment, bonds have their own set of pros and cons:
- Steady, fixed-income investment
- Higher yield than savings accounts
- Could provide tax benefits
- May offer regular interest payments
- Help fund causes you want to support
- Less risky than stocks
- Clear risk ratings
- High minimum investment (Usually $1,000)
- Broker fees if you want to buy or sell on the secondary market
- Less liquidity if you need access to cash
- Lower returns than stocks and other investments
- Bond prices fall when interest rates increase
- Risk of issuer defaulting
How are bonds valued?
A bond’s capital value can increase or even decrease before the maturity date based on the current interest rates.
The amount of interest accrued since the last payment will also have an effect on the value of a bond. If interest rates drop, you’ll see an increase in the value of your bonds, whereas if they rise, the value of your bonds will drop as a result. These fluctuations are only relevant if you’ve invested in floating rate bonds as opposed to fixed-rate bonds because the interest varies in line with the benchmark interest rate.
This investment has the potential to earn higher returns but there is also a risk of lower returns if the interest rate drops.
How do I choose a bond to invest in?
If you are interested in diversifying your investments with bonds, you’ll first need to decide which type of bond is right for your financial strategy:
|Type of bond||Issued by||Risk||Reward||Purpose|
|Treasury Bills||Government||Very low||Very low||Finance government debt, capital expenditures, etc.|
|Singapore Government Securities (SGS)||Government||Very low||Low||Finance government debt, capital expenditures, etc.|
|Singapore Savings Bonds (SSB)||Government||Very low||Low||Finance government debt, capital expenditures, etc.|
|Quasi-Government Bonds||Government-linked entities||Low||Low||Finance growth, debt, capital expenditures, research, and specific needs from the government subdivision.|
|Corporate bonds||Companies||High||High||Finance growth, debt, capital expenditures, research|
*As there’s no capital gains tax in Singapore, all individual investors are exempted from tax payment for interest earned from their bonds.
If you’d like to diversify your investment even further, you can invest in something called a bond fund. A bond fund is a mutual fund or ETF that is comprised of multiple bonds with varying risk levels, maturity dates and yields.
This provides instant diversification and allows investors to participate in multiple bonds without paying for individual transaction fees. Instead, you’ll pay an annual expense ratio which also gives you access to a professional portfolio manager that will do all the research, analysis and management for you.
How to buy bonds
Now that you’ve decided which type of bond you’d like to buy, there are a few ways to make an initial purchase.
If you’re looking to buy new-issue bonds, you can purchase them on the primary market, which is usually directly from the issuer.
Individual investors may purchase T-bills, SGS and SSB bonds at MAS Bills Auction. The auction typically takes place 3 business days before issuance and are announced on the SGS website 5 business days prior. You may apply for the auction through local banks’ ATMs or internet banking portals, as well as your SRS/CPFIS funds. The minimum denomination to purchase SGS is $1,000, and you can invest in multiples of $1,000. For SSB, the minimum investment amount is $500.
New-issue corporate bonds are not usually available to the public, as most of them are sold to large institutions and banks which sell them in the secondary market. While unlikely, you may be able to purchase them directly from the underwriting investment bank in an initial bond offering.
The secondary market is where you’ll find investors and other institutions looking to resell existing bonds. This is done through brokers, which are a third party that allows you to purchase bonds from another entity on your own or with the help of an investment representative. You’ll specify which bonds you’d like to purchase and the broker will search for another person selling them, then purchase them for you, often with a markup to cover commission.
Brokers can also help you resell bonds before they reach maturity. Once you’ve purchased a bond, you can choose to hold it until maturity or sell it on the secondary market. You’re not required to pick one or the other, so there’s nothing stopping you from collecting interest then reselling the bond if its value increases.
Bonds can be a prudent way to keep your money safe over a long period of time and are a great way to diversify your portfolio. Splitting your savings between a traditional savings account and a government or corporate bond can help you earn interest on your money without taking on too much risk.
Assess your financial situation and compare your investing options to determine whether buying a bond is right for you.
Picture: Getty Images
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