Investing in bonds might seem confusing at first, but don’t worry – I’ve been through it myself, and I’m here to break it down for you in simple terms.
Whether you’re looking for stability, predictable income, or just trying to diversify your portfolio, bonds can be a solid option.
In this post, you’ll learn:
- What bonds are and how they work
- How to earn money from bonds
- The types of bonds available in Singapore
- Key factors and metrics to consider before investing
If you’re looking for a safe, reliable way to grow your money while avoiding the rollercoaster of the stock market, keep reading!
What are bonds and how do they work?
Bonds are essentially a form of loan, but instead of going to a bank, you’re lending your money to a government or a corporation.
In return, you earn interest on the loan until the bond reaches its maturity date, which then you will receive the par value of the bond.
You can usually expect regular interest payments until the bond matures.
It’s a straightforward way of generating a steady income, and many investors love bonds as it’s a safer option than riskier investments like stocks.
How do I earn money from bonds?
Coupon payments
When you buy a bond, you agree to lend your money to the issuer (like the government or a company), and in return, they pay you regular interest – these are called coupon payments.
These payments are made on a fixed schedule, typically semi-annually or annually, providing a steady income stream.
The best part is that this interest is tax-free in Singapore for individual investors, making bonds particularly appealing.
With bonds like Singapore Savings Bonds (SSBs), there’s also a step-up coupon rate, meaning the longer you hold the bond, the higher the interest you’ll earn.
Capital gains
While it is possible to make money from capital gains, it’s not something to expect too much from bonds.
This is because capital gains occur when you sell a bond for more than you paid.
This can happen if interest rates fall after you buy your bond, making your older bond (with a higher coupon rate) more attractive to other investors.
Theoretically, you could sell your bond at a higher price and pocket the difference.
However, in reality, most people buy bonds for stability and income rather than short-term profits.
Bonds tend to trade in a narrow price range, and unless there’s a significant shift in interest rates, the capital gain potential is limited.
Unlike stocks, which can skyrocket in value, bonds are much more predictable.
You’re likely to earn most of your money from the coupon payments rather than trying to sell your bond at a higher price.
Why invest in bonds?
Stability and lower risk
Unlike stocks, which can swing up and down with the market, bonds are much safer.
When you invest in a bond, you’re essentially lending money to a government or company, and in exchange, you get regular interest payments.
At the bond’s maturity, you also get your original investment (the principal) back.
This level of predictability is especially attractive for conservative investors or those nearing retirement who don’t want to risk their hard-earned savings in a volatile stock market.
Predictable income
Bonds offer a reliable stream of income through regular coupon payments.
These payments are made on a set schedule – typically semi-annually or annually – so you know exactly when to expect them.
This can be particularly helpful for retirees or anyone wanting to cover ongoing expenses without fearing market fluctuations eating into their returns.
Diversification and risk reduction
Bonds act as a safety net in your investment portfolio.
While stocks can offer high returns, they also come with high risk.
Bonds, on the other hand, tend to perform better when stocks are struggling.
This makes bonds a great counterbalance to more volatile investments.
Having bonds in your portfolio can reduce your overall risk, especially during economic uncertainty.
Capital preservation
If preserving your initial investment is a priority, bonds are an excellent choice.
Most bonds repay the full principal at maturity, meaning you get back what you put in, plus the interest earned along the way.
This particularly appeals to short-term financial goals or investors who want to protect their capital in a low-interest environment.
It’s a much safer bet than investing solely in stocks, where your capital is more at risk.
Inflation protection (for some bonds)
Certain bonds, like Singapore Savings Bonds (SSBs) or U.S. Treasury Inflation-Protected Securities (TIPS), offer a hedge against inflation.
These bonds adjust their interest rates to keep pace with rising inflation, ensuring your purchasing power isn’t eroded over time.
This feature is handy in an environment where inflation is on the rise, helping to maintain the actual value of your investment.
Types of bonds available
Corporate bonds
Corporate bonds are issued by companies looking to raise capital for their operations, expansions, or other business needs.
When you invest in a corporate bond, you’re essentially lending money to a company in exchange for regular interest payments, known as coupons.
While corporate bonds can offer higher returns than government bonds, they come with higher risks.
If the company runs into financial trouble, there’s a chance they could default, meaning you might not get your money back.
Corporate bonds come in 2 main flavours: investment-grade bonds and junk bonds.
Investment-grade bonds are issued by companies with strong financial health and credit ratings.
These are safer, but the trade-off is lower returns.
On the other hand, junk bonds are issued by companies with lower credit ratings.
They offer much higher returns but come with a higher risk of default.
Halal bonds (Sukuk)
For those looking for Shariah-compliant investment options, Sukuk bonds are the go-to.
Unlike conventional bonds, which involve interest payments (riba), Sukuk is structured to comply with Islamic law.
Instead of lending money and receiving interest, when you invest in Sukuk, you buy a share of an asset or project, and your returns come from the profits generated by that asset.
This structure makes Sukuk fundamentally different from traditional bonds because they’re asset-backed, representing ownership in real assets.
The risk and reward are shared between the investor and the issuer, and profits are distributed instead of interest.
For Muslim investors seeking ethical, halal-compliant investments, Sukuk is an excellent option, though it also attracts non-Muslim investors due to its stability and returns.
Government bonds
Government bonds are considered one of the safest investments you can make.
When you invest in a government bond, you’re lending money to the government, which uses it to fund public projects like infrastructure or education.
In return, you receive regular interest payments, and at maturity, the government repays your principal.
Because governments, particularly in developed countries, are less likely to default, these bonds are seen as low-risk investments.
In Singapore, you have 3 types of government bonds to choose from.
Singapore Savings Bonds (SSBs) are ideal for investors looking for a low-risk, flexible investment.
Backed by the Singapore government, these bonds come with a step-up interest rate, meaning the longer you hold them, the higher your interest.
They’re also very liquid – you can redeem them anytime without penalty, which makes them an excellent option for those who want to preserve capital while earning steady returns.
Singapore Government Securities (SGS) bonds are similar to SSBs but are aimed more at institutional investors.
These bonds offer a fixed interest rate in tenures ranging from 2 to 50 years.
SGS bonds are great for long-term investors looking for guaranteed, tax-free income over an extended period.
If you’re looking for a short-term investment, Treasury Bills (T-Bills) could be the way to go.
They typically have maturities of 6 or 12 months, making them a good option for those who want a low-risk place to park their money for a short period.
T-Bills don’t pay regular coupon payments like other bonds.
Instead, they’re sold at a discount to their face value, and you get the full amount back when they mature.
Here are some key factors to consider when investing in bonds
Interest rates
There’s an inverse relationship between bond prices and interest rates.
When interest rates rise, the value of existing bonds falls.
Why?
Because newer bonds issued at higher rates become more attractive to investors, so existing bonds with lower rates are worth less.
If you plan to sell your bond before it matures, you might have to sell it at a discount.
However, if you hold your bond to maturity, you’ll still receive your regular coupon payments and get your full principal back.
This means that bonds are particularly attractive in low-interest rate environments, as their value tends to rise when interest rates are stable or falling.
Conversely, when interest rates are expected to rise, bonds become less attractive as their market value tends to drop.
Credit risk
Credit risk refers to the risk that the bond issuer might default on their payments.
In other words, they might be unable to make the interest payments (coupons) or repay the principal when the bond matures.
This is a critical factor to assess when investing in corporate bonds, as companies sometimes face financial difficulties that lead to default.
Bond yield
Bond yield is the return on your bond investment, typically expressed as a percentage.
There are a couple of ways to measure bond yield:
- Current yield: This is calculated by dividing the bond’s annual coupon payment by its current price. For instance, if a bond has a face value of S$1,000, pays a 3% coupon (S$30 per year), and is currently trading at S$950, the current yield would be about 3.16%.
- Yield to maturity (YTM): This is the total return you’ll earn if you hold the bond until it matures, accounting for both the coupon payments and any capital gains or losses (if you didn’t buy the bond at its face value). YTM gives you a more comprehensive picture of a bond’s potential return.
Keep in mind that higher yields often come with higher risk, especially for corporate bonds.
Bonds with high yields may seem attractive, but they often signal higher credit risk or interest rate risk.
Maturity
The maturity of a bond refers to the length of time until the bond’s principal is repaid.
Bonds can range from short-term (under 3 years) to medium-term (3 to 10 years) and long-term (over 10 years).
Maturity is important because it affects both the bond’s risk and its returns.
Short-term bonds are less sensitive to interest rate changes.
They’re lower-risk but typically offer lower yields.
Long-term bonds, such as SGS with maturities of up to 50 years, usually offer higher yields because investors are taking on more interest rate risk over time.
However, long-term bonds can be more volatile if interest rates rise, reducing the bond’s market value.
Inflation
Inflation erodes the purchasing power of the income you earn from bonds over time.
If inflation rises, the actual value of your interest payments diminishes, meaning the money you receive will buy less in the future.
If inflation outpaces your bond’s yield, the actual value of your returns could decline.
Liquidity
Liquidity refers to how easily you can buy or sell a bond without affecting its price.
Highly liquid bonds can be sold quickly at or near their market value, while illiquid bonds might be harder to sell or could require you to sell at a discount.
Call risk
Call risk refers to the risk that a bond issuer may repay the bond before its maturity date, known as calling the bond.
Issuers typically do this when interest rates drop, allowing them to refinance their debt at a lower rate.
This can be frustrating for investors because it means losing out on future coupon payments that you were expecting, especially if you’re then forced to reinvest at a lower interest rate.
Bonds that have this feature are known as callable bonds, and they often come with higher yields to compensate for the added risk.
While this might seem attractive initially, it’s important to know that your bond could be called away just when you’re enjoying the benefits of its higher returns.
What are some key metrics I should look at when investing in bonds?
Coupon rate
The coupon rate is the annual interest rate the bond issuer agrees to pay you based on the bond’s face value.
It’s essentially the fixed amount you’ll receive as interest each year.
The coupon rate remains the same throughout the bond’s life, but its significance can change depending on the interest rate environment.
For instance, in a low-interest-rate period, bonds with higher coupon rates become more attractive because they offer higher returns than new bonds issued at lower rates.
Conversely, in a high-interest-rate environment, bonds with lower coupon rates might lose some appeal as newer bonds offer better returns.
The coupon rate is important for investors who rely on regular, predictable income, like retirees.
It allows you to gauge the income the bond will generate each year.
Yield to maturity (YTM)
Yield to maturity (YTM) is a more comprehensive metric that calculates the total return you can expect to earn if you hold the bond until it matures.
Unlike the coupon rate, which only considers the bond’s fixed interest payments, YTM takes into account:
- The bond’s current price: If you buy a bond at a discount (below its face value), you’ll earn not only the coupon payments but also a capital gain when the bond matures. If you buy at a premium (above face value), your total returns will be reduced.
- Coupon payments: The regular interest you’ll receive throughout the bond’s life.
- The time to maturity: The number of years remaining until the bond matures.
- Face value repayment: The principal amount you’ll receive when the bond matures.
YTM is often viewed as a more accurate representation of a bond’s profitability because it factors in all investment elements.
YTM can fluctuate depending on the bond’s market price.
If interest rates fall, bond prices rise, and the YTM decreases since new investors will pay more for the bond but still receive the same coupon payments.
Current yield
The current yield gives you a snapshot of how much income a bond will generate based on its current price rather than its original face value.
It’s calculated by dividing the bond’s annual coupon payment by its current market price.
The current yield helps you evaluate how much income you can expect from a bond based on its market value today rather than when it was issued.
However, it doesn’t take into account the bond’s maturity or any capital gains or losses you might incur if you buy the bond at a price that’s different from its face value.
For that, you’d need to look at yield to maturity (YTM).
Credit rating
Credit rating is a critical metric that measures the financial health of the bond issuer and their ability to make interest payments and repay the principal at maturity.
Bond ratings are provided by agencies like Standard & Poor’s (S&P), Moody’s, and Fitch.
These agencies assign ratings based on the issuer’s creditworthiness.
Understanding a bond’s credit rating helps you gauge the risk of default and decide whether the potential returns are worth the risk.
Maturity date
The maturity date is the point in time when the bond issuer is required to repay the principal, or face value, of the bond to you.
Bonds can be categorised into three types based on their maturity:
- Short-term bonds: These mature in less than 3 years.
- Medium-term bonds: These mature between 3 and 10 years.
- Long-term bonds: These mature in 10 years or more.
The bond’s maturity is important because it affects both the risk and return of your investment.
Short-term bonds are less sensitive to interest rate fluctuations and are generally safer, but they tend to offer lower yields.
Long-term bonds provide higher yields as compensation for taking on the risk of locking in your money for a longer period.
Still, they’re more sensitive to interest rate changes (higher duration).
Price
The price of a bond fluctuates after it’s issued, based on market conditions, interest rates, and the issuer’s creditworthiness.
A bond’s face value (par value) is typically set at S$1,000 or another standard amount when it’s issued.
However, once it’s traded on the secondary market, its price can go above (premium) or below (discount) at face value.
- Premium: If the bond’s price is above its face value, it’s said to be trading at a premium. This usually happens when interest rates have fallen since the bond was issued, making its higher coupon rate more attractive than new bonds.
- Discount: If the bond is trading below face value, it’s said to be at a discount. This can occur if interest rates have risen, making the bond’s lower coupon rate less attractive than newly issued bonds.
Price plays a crucial role if you plan to trade bonds before maturity, as it will impact both your income and potential gains or losses.
Who are bonds suitable for?
Risk-averse investors
If you prefer to play it safe with your money, bonds could be perfect for you.
Bonds, especially government bonds like Singapore Savings Bonds (SSBs) or Singapore Government Securities (SGS), are much less volatile than stocks.
They provide a steady stream of income through regular interest payments, and at the end of the bond’s term, you get your principal back.
This makes bonds an ideal choice for those seeking higher interest than bank deposits but with minimal risk.
Portfolio diversifiers
Bonds are also great for investors looking to diversify their portfolios.
By including bonds in your investment mix, you can balance the higher-risk, higher-reward nature of stocks or equities.
Bonds often perform well when the stock market is volatile, offering a safety net during economic downturns.
Bond diversification can reduce your overall portfolio risk, making your investments more resilient.
Income investors
Bonds appeal to income investors because they offer regular, predictable interest payments, providing a steady income stream.
Unlike stocks, bonds are generally lower-risk investments, making them a more stable choice for investors focused on preserving capital while generating a predictable income stream.
Government and high-quality corporate bonds, in particular, are viewed as reliable income sources due to their lower likelihood of default.
For income investors, bonds can balance a portfolio by providing stability while still contributing to overall returns.
Frequently Asked Questions
Is Singapore savings bond worth buying?
Yes, Singapore Savings Bonds (SSBs) are worth buying if you want a safe and flexible investment option.
Backed by the Singapore government, SSBs offer low risk and a step-up interest rate, meaning the longer you hold them, the higher your returns.
How long are bonds issued for?
Bonds can be issued for varying periods, from as short as 6 months (Treasury Bills) to as long as 50 years (Singapore Government Securities).
The duration depends on the type of bond and the issuer.
Why do bonds have different coupon rates?
Bonds have different coupon rates because they reflect the prevailing interest rates and the credit risk of the issuer.
Higher-risk issuers offer higher coupon rates to attract investors.
Conclusion
So, there you have it – a full breakdown of what bonds are, how they work, and why they might be a solid addition to your investment portfolio.
We’ve covered the different types of bonds, from corporate bonds to Singapore Savings Bonds, and highlighted the key factors you should consider, such as interest rates, maturity dates, and credit ratings.
Bonds offer stability, predictable income, and a good way to diversify your investments.
If you’re still unsure whether bonds are right for you, or if you want help navigating your options, don’t worry – you’re not alone!
Our trusted financial advisor partners are here to help.
They can offer you personalised, unbiased advice at no cost, so feel free to reach out and get all your questions answered.
