Thursday, September 29, 2016

Why Singaporeans In Their 20s Shouldn't Invest All Their Money In Bonds

(Singsaver.com.sg, Singapore's leading personal finance comparison platform, provides free and easily accessible resources such as its up-to-date credit card product page and the latest personal loan packages available in real-time.)

Corporate bonds will be available to the average Singaporean in 2016. While older investors will benefit from this, 20-somethings should be careful about buying them. The recent incident with Swiber bonds left many investors burned. And with more bonds becoming available to retail investors (read: the average Singaporean), there are some potential hazards on the horizon.
 
What Are Bonds, and Why Will You Want to Buy Them?
Your wealth manager will nag you into buying corporate bonds in Singapore soon. Bonds are fixed income assets*. While they do not have the potential to pay out as much as stocks, they provide a predictable and consistent stream of cash. Wealth managers will often advise older investors to reallocate to bonds. This is to shift emphasis from income growth to wealth protection. We’d like to emphasise that this is not a lie. The only reason you seldom heard about bonds before is because they used to be the province of wealthy individuals. They have only now started to become accessible to the average Singaporean, where they will be an important retirement tool. That being said, there are a few ways to lose money investing in bonds: (*Actually, not all bonds work this way. And the term “fixed income” has been a misnomer for a while now. But the vanilla bonds that will be available to regular Singaporeans mostly do.)
 
1. Place All Your Money in Bonds, Especially at a Young Age
Bonds provide consistent, fixed income. So the risk averse types will naturally love them, and some will go overboard and load up almost entirely with bonds. This is a terrible idea, particularly if you’re young. The interest rate on a bond may not grow with inflation. If a 10-year bond promises four per cent per annum, you get exactly four percent, even if the inflation rate rises to match it. A lot can happen to the inflation rate over 10 years (assuming you hold the bond to maturity, as passive investors are wont to do). You may find, at the end of it, that you’ve effectively lost money as inflation outpaced the interest. This is less of a problem for older investors. But for young investors, who have decades to go, too many bonds can dangerously impair the growth of their retirement fund.
 
2. Buy Unrated Bonds
If you happen to be wealthy enough, unrated bonds might be pushed on you. These are essentially cases when the bond-issuer does not want to pay an agency to rate them. In some cases, these make sense. For example, a bond from McDonald’s or Apple may be unrated, and still be a pretty good deal (it’s doubtful either will go bankrupt tomorrow, or even in the next 50 years). However, bonds can also be issued by questionable companies. And when those companies issue an unrated bond, they don’t haven’t been thoroughly vetted by a third party. They may not even have to prepare proper financial documents. You also cannot assume the person selling the bond has performed appropriate checks. After all, they are getting a commission for selling the bond to you. You’re buying blind, and if the company goes broke (or worse, turns out to be a fly-by-night scam), your bond is a useless piece of paper. Don’t lend money to people you don’t know.
 
3. Assume Bond Ratings Are Guarantees of Financial Stability
The bonds available to retail investors are usually AA or AAA (investment grade). However, you should understand that the ratings are an opinion – by a credit agency –  about the financial stability of the company. It is not a form of guarantee. During the Global Financial Crisis in 2008/9, several established companies had high credit ratings the day before they collapsed. Bear Stearns and Lehman Brothers are both examples of this. Remember that the opinion of the credit agency is (1) not necessarily correct, and (2) in no way guarantees safety. No one is guaranteeing anything with the rating. Thinking that the bond rating is a recommendation is always a way to lose money. AAA suggests the company issuing the bond is probably financially stable. “Financially stable” is not the same as good. The bond yields may be terrible in comparison to other options. And depending on your retirement goals, it may still be an inappropriate product for you.
 
4. Buy Bonds When You Need Liquidity
With a few conditions, you generally can’t change your mind and ask for your money back anytime you want. To get your cash out of a bond, you’ll generally have to sell it. There is no guarantee that you won’t make a loss; if interest rates have gone up significantly, few people will want to buy your low yielding bond. This means that, if you need liquidity but your money is tied up in bonds, you might be in trouble. If you don’t sell at a loss, you may be stuck with taking up a loan. Both options are going to cost you money. Before committing large sums to bonds, make sure you have savings on hand. Don’t start locking your money in bonds when you plan to buy a house in three years, or when you might need to pay medical costs in the near future. We suggest you keep an emergency fund of at least three months of your income before you start buying bonds. An exception to this is Singapore Savings Bonds, in which you can cash out any month. However, the interest on Singapore Savings Bonds is low, especially if you need to cash out early.

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