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Invest in Bonds That Don't Drain Your Travel Funds

Feb 22, 2019 | 10m

Gain Actionable Insights Into:

  • Why you can’t ignore the bond market and should follow smart money economics
  • The different types of bonds, what they entail and what you need to know before investing
  • Understanding credit securities, yield to maturity and all things associated with bonds
  • The key risks, terms and economic indicators to look out for to make better investment decisions


The World of Bonds

Most people don't realise how big the bond market is. Everyone is following what’s happening with stocks like the Apple share price, but Apple has over 300 bonds. Each of these bonds is slightly different and worth a few hundred million. You shouldn’t ignore the bond market because its market value is much larger than the stock market. The U.S. Publicly Traded Stocks is about $27 Trillion while the U.S. Bond is about $40 Trillion. The Global Publicly Traded Stocks is $70.1 Trillion while Global Bonds is $92.2 Trillion.

So how do stocks and bonds differ? If you own shares of stocks in a company, you are an “owner” but if you own a bond of a company, you are a “loaner”. When you buy a bond, you're loaning a sum of money to its issuer for a specific period of time. In exchange, the issuer promises to make regular interest payments at a predetermined rate until the bond period ends. They then repay your principal amount upon maturity. For example, you might buy a 10-year, $10,000 bond paying 3% interest. The issuer, in exchange, will promise to pay you the interest on that $10,000 every six months, and then return your $10,000 after ten years.

It is often said that the bond market is smarter than the stock market and there’s a lot of truth to this. The bond market provides useful insight into the future state of the economy through the shape of the yield curve (a conglomeration of bond yields at various maturities). An inverted yield curve, which means that short-term rates are higher than long-term rates, has correctly predicted the last seven recessions dated back to the late 1960s. The last two times the yield curve inverted was in the years 2000 and 2006, before each of the last recessions. While the stock market is also somewhat of an economic indicator, it is more of an emotional and volatile market. The mid-cycle sell-offs in the stock market, which are common, are easily confused as signals of an impending recession.

Bonds have developed so intricately from a personal level loan to a mass level loan. In the past, companies that wanted to start growing had to find partners who would lend them money. This was at a time when there was no real trust or governance around lending money, so there was no form of guarantee. As such, for companies to get money and grow, they had to offer equity to partners. When the law came along, and records were better kept, loans started getting issued officially. When the government began taxing people, wars were started because taxes were too high. This then caused the creation of a system where the government loaned a certain amount from citizens and then returned it with interest. Such a concept extended across to farms, big industries, and filtered down to small corporates. Bonds became preferred over equity because companies preferred to give less ownership to others. As a result, the bond market expanded quickly. What started as a simple loan between two people has become large scale loans between conglomerates and hordes of people.

Due to this natural development of bonds, they don’t just come in one form. They come in multiple shapes and forms, and I’ll lay this out for you in the next chapter.


Shape and Form of Bonds

There are two ways to make money from investing in bonds. The first is to hold bonds until their maturity date while collecting interest payments twice a year. The second way to profit from bonds is to sell them at a price that's higher than what you paid for initially. For example, if you buy $10,000 worth of bonds and then sell them for $11,000 when their market value increases, you can pocket the $1,000 difference.

Before you can begin doing that, you need to be familiar with the several varieties of bonds – corporate, municipal, and government – and even though their nuances might differ, they're all the same at their core: debt instruments used to raise capital.

Treasury Bills

Treasury bills are short-term debt securities issued by the treasury department of countries. For instance, the Monetary Authority of Singapore (MAS). Treasury bills typically have a maturity of one year or less. Due to the short-term nature of these bonds, there may be no coupon payments paid on these bonds. Instead, they are usually sold at a discount to their par value, or the amount you will receive at the end of the bond. The difference between the price of the bond and its par value makes up returns earned by investors. For instance, a bond worth $10,000 with a 1-year maturity could be sold for $9800, and an investor would pay $9800 now and receive $10,000 in 1 year.

Government Securities

Government Securities are longer termed debt securities issued by the governments, usually with maturity periods ranging from 2, 5, 10, 15, 20 and 30 years. In Singapore, the Singapore Government Securities (SGS) bonds pay a fixed coupon, usually every six months, for the entire duration of the bond. Upon maturity, investors will receive the par value of the bond. The current Singapore 5 year bond has a 2% coupon annually, paying every 6 months until it expires in 2024 returning the par value invested.

Savings Bonds

A savings bond is a 10-year bond issued by a country. In Singapore, it is issued by MAS and backed by the Singapore Government, which also makes it a virtually risk-free investment. Singapore Savings Bonds (SSB) and Government Securities are very similar; both are issued by the Government of Singapore, and both are very safe. The key difference relates to the investment amount. SGS Bonds come in multiples of $1,000 and have no real maximum limit. SSB come in a smaller multiple of $500 and have limits: maximum of S$50,000 per issue and a maximum of $100,000 across all issues.

The ABF Singapore Bond Fund

This fund comprises of some of the safest and highest rated debts issued in Singapore. These usually include high-quality bonds that are issued by the Singapore Government and quasi-Singapore Government organisations. The quasi Singapore government issuers are the likes of Temasek, Port Authority of Singapore, Singapore Housing Authority, and other public organisations.

Corporate Bonds

The price of these bonds could be more volatile as they are dependent on the performance of the company that issued them, market sentiments as well as the interest rate environment. Especially if they are unrated or junk bonds - a term commonly reserved for younger and riskier companies.

Junk bonds are the most alluring types of bonds to new investors because of the high, double-digit yields during ordinary interest rate environments. These dangerous bonds can lure you in with the promise of big checks in the mail, yet leave you high and dry when the companies that issue them miss payments or go bankrupt. Stick to investment grade bonds instead. If you don't know what you are doing, be extra safe.

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Gareth Nicholson

CIO & Head of DPM of International Wealth Management




Investing Intelligently