For investors who want to take on less risk with more modest returns, fixed income investments (also known as bonds) could be what you’re looking for. Here’s how they fit into your portfolio.
In today’s world of meme stocks, high-valuation technology stocks and volatility in the cryptocurrency market, supernormal returns seem to be, well… the norm that new investors strive to achieve. However, it’s not every day that the man on the street can multiply their portfolio value by tenfold — at least, not without a heightened degree of risk.
For the risk averse, fret not — there are still plenty of investment options for you to choose from, be it the steadier blue chip stocks, well-diversified, index-tracking exchange traded funds (ETFs) or fixed income investments.
This article will break down all you need to know about investing in fixed-income products.
- What are fixed income investments?
- Why invest in fixed income?
- What are the risks involved when investing in fixed income?
- Types of fixed income investments in Singapore
- How much of your portfolio should you allocate to fixed income?
What are fixed income investments?
Fixed income investments, also known as bonds and often used interchangeably, are a low-risk investment asset class.
They are a type of debt instrument that can be issued by governments and companies. These entities borrow investors’ money and pay interest in return, so that they have the capital required for purposes such as expansion and growth.
When you invest in a bond, you invest a fixed lump sum of money in return for regular coupon payouts over a predetermined period of time. The interest returns you receive for these coupon payouts are typically fixed even before you apply. At bond maturity, you will also get back your principal.
Here’s a simplified example of what a bond might look like:
- Interest rate (Coupon payout): 3% p.a., given out semi-annually
- Maturity date: 10 years
- Minimum investment amount: S$1,000
So if you were to invest S$10,000 in the bond above, you’ll receive S$300 per year for 10 years before finally receiving your capital of S$10,000 at bond maturity. This would total S$13,000 in interest and capital.
|Pros of fixed income products||Cons of fixed income products|
|Stable asset class with foreseeable returns||Risk of default|
|Diversification of portfolio||Low rate of return compared to other investment types (inflation risk)|
|Preserve starting capital||Low liquidity|
|Steady stream of income||Interest rate risk|
Why invest in fixed-income products?
#1 Stable asset class
Fixed income investments come with expected payouts. This gives you some visibility into the returns that you will receive in the coming months or years. Compared to other classes that fluctuate depending on the market conditions, fixed-income products provide that layer of stability to an investment portfolio.
#2 Diversification of portfolio
Besides providing stability to a portfolio, fixed-income products also help investors to diversify their portfolio. This means spreading your eggs across multiple different baskets, helping to balance out the volatility of asset classes such as stocks and commodities.
#3 Preserve investment capital
Having understood the concept of bonds, you’ll see that bonds are one way to help you preserve your starting capital. Coupon payouts aside, you’ll receive your principal amount at the end of the tenure. This is especially so for bonds that are backed by the government, such as the Singapore Savings Bonds.
There is just one caveat — there are higher risk bonds around that could end up with the company defaulting on the bond.
#4 Steady stream of income
By giving coupon payouts in regular tenures, this gives you, the bond-holder, a consistent stream of income. This is similar to how annuity plans work.
What are the risks of investing in fixed-income products?
As safe as fixed income might sound, like all other investment products, it comes with its own set of risks.
#1 Risk of default
The biggest risk of fixed-income products is the issuing party defaulting on the bond. When a company defaults on a bond, not only will you fail to receive the coupon payouts, you could also lose your investment capital.
This is why it’s important to check the credit rating of the bond. The better the bond issuer’s credit rating, the lower the risk of default as the rating reflects the issuer’s creditworthiness. For example, on the S&P Global Ratings scale, the highest grade is AAA, followed by AA and A — all of which are investment grade ratings.
If you’re risk-averse, you should opt for bonds with investment grade credit ratings, or bonds that are backed by the government.
#2 Low rate of return compared to other investment types
Fixed-income products typically offer low returns. This means that they face inflation risk — the risk of having your capital eroded (outpaced) by inflation.
As such, you could be better off putting the money into products that offer higher returns, with higher liquidity. Examples of such products include cash management accounts and the lower risk portfolios offered by robo-advisors.
#3 Low liquidity
Bonds come with a maturity period. This means as a bond-holder, you’ll have to hold onto the bond for the stipulated number of years in order to receive the full coupon payouts and your principal capital at the end of the tenure. In essence, your money is locked up for those years. There are a few exceptions, such as the SSB, that allow you to withdraw your capital anytime.
There is another way out: sell it on the stock exchange. However, these bonds listed on the exchange can have low liquidity. This means that there could be little demand for the bonds. Without a willing buyer, you’ll be unable to sell off your bond on the market.
#4 Interest rate risk
When interest rates rise, the market price of existing bonds tend to fall in tandem as new bonds with higher returns are introduced and you face higher opportunity costs of holding onto your bond. However, this is a risk you’re exposed to only if you have plans to sell the bond before the maturity date.
This is also why in a low interest rate environment, it’s going to be difficult to find bonds that pay out a high yield. For example, for the later half of 2020 and early 2021, new SSB issuances had average returns of less than 1% p.a.
Types of fixed income investment products in Singapore and how to buy them
Here are some fixed income investments you can purchase in Singapore, particularly if you’re looking to DIY your portfolio.
- Singapore Savings Bonds (SSBs)
The most well-known bond in Singapore, SSBs are a type of Singapore Government Securities that is issued and backed by the government of Singapore. The minimum investment amount is S$500 and you can only hold a maximum of S$200,000 in SSBs at any one time.
The interest returns of SSBs vary every month, typically ranging between 0.8% p.a. to 2% p.a. It is best that you hold your SSBs for the full ten years in order to enjoy the full interest returns, though you are still allowed to withdraw anytime.
You can purchase SSBs through DBS/POSB, OCBC and UOB ATMs or via internet banking. Check out this month’s SSBs bond here.
- Singapore Government Bonds (SGBs)
SGBs are bonds issued by the government of Singapore with AAA credit rating. The minimum investment amount required is S$1,000, with bond maturities ranging from two to 30 years. SGBs pay a fixed rate of interest, with interest payments given every six months, starting from the month of issue.
Check out the latest SGBs on the MAS website.
Government bonds aside, there are also other corporate bonds that could be issued throughout the year. For example, Azalea Asset Management released the Astrea VI Private Equity Bonds in March this year, where keen investors had just six days to submit their applications.
Besides directly applying for these bond issuances, you can also purchase bonds on the SGX.
- Purchase bond exchange traded funds (ETFs)
ETFs are funds that consist of a basket of securities, typically looking to replicate the performance of an index. A bond ETF, such as the ABF Singapore Bond Index Fund or the Nikko AM SGD Investment Grade Corporate Bond ETF, would contain numerous different investment grade bonds.
ETFs are listed on the stock exchange and hence can be purchased and sold just like a stock. They are also highly affordable with a low minimum investment amount. You can even use your CPF money to purchase approved bond ETFs.
- Purchase a unit trust/mutual fund
Just like how you can purchase ETFs for exposure to a basket of bonds, you can also purchase a unit trust that invests in bonds. Unit trusts (also known as mutual funds), are funds made up of money pooled together by fellow investors and managed by a fund manager.
These unit trusts can be purchased on your own or via a regular savings plan.
Finally, you can even get exposure to fixed income funds via insurers and their investment-linked policies (ILPs). However, if you’re looking for an insurance plan that offers low risk and modest returns, you can instead consider endowment plans, which come at a lower cost.
How much of your portfolio should you allocate to fixed-income products?
The answer to this depends on various factors, including your risk appetite, investment goals, investment capital and age.
When to allocate more? If you’re risk-averse, you’ll want to allocate a greater portion of your portfolio towards fixed income investments. The same applies if you’re older as risk appetite correlates to age. For example, if you’re approaching retirement age, time is no longer on your side and you might not be able to afford losing your investment capital.
When to allocate less? On the flipside, if you’re young, you have a long investment time horizon. This allows you to take on higher risk as your portfolio has the time to tide over market volatility in the long term, particularly as stock markets have shown to go up over time.
Taking on some risk when you’re young gives your portfolio the opportunity to earn higher returns over time. This means investing in asset classes such as stocks, exchange traded funds (ETFs), unit trusts and perhaps even putting a tiny portion into more speculative assets such as cryptocurrency or collectibles.
If you need help deciding how much of your portfolio to allocate to fixed income, consider robo-advisors.
Robo-advisors offer a diversified portfolio that consists of asset classes allocated based on your risk appetite. They suggest and tailor a portfolio for you based on your risk profile and investment goals. These portfolios are well-diversified, typically investing in a mix of both equities and fixed-income products.
For example, an investor with lower risk appetite might be offered a portfolio with 60% fixed income and 40% equities, while an investor that’s willing to take on more risk could go with a portfolio with 80% equities and 20% fixed income.
Instead of sitting on the fence, start growing your investment capital with a robo-advisor today.
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By Ching Sue Mae
A flat white, an adventure-filled travel and a good workout is her fuel. This Manchester United fan enjoys sharing knowledge on personal finance while chasing the dream of financial independence.