Investment 101: Getting to know bonds
Hey guys! In the first part of this series, we discussed unit trust as a form of investment. Today, we’ll be moving on to talk about bonds. With retail bonds and bond funds, individual investors like us can also enjoy a slice of this pie!
So, let’s get started!
What is it?
Bonds are debt instruments issued by governments or companies to raise money. So, when you buy bonds, you are essentially giving governments or companies a loan.
What is the minimum investment?
In Malaysia, you can buy retail bonds from as low as RM 1,000. If retail bonds are not available in your country, look into bond funds instead.
What are the fees or charges involved?
Depending on the trading platform, you may incur processing and platform fees.
How do I earn return?
With fixed deposit (FD), you refer to the interest rate to find out how much return you can earn each year. Likewise, with bonds, you refer to the ‘yield to maturity.’ This tells you roughly how much return you can earn each year by buying and holding bonds up to maturity. Bondholders receive coupon payments (kind of like interest) semi-annually or annually. At the bond’s maturity date, bondholders are returned the nominal value of their bonds. Investment platforms that sell retail bonds usually have a bond calculator that can help you figure out how much coupon payments you will receive periodically and how much you will be repaid at maturity.
For e.g. the above is a screenshot of a bond calculator for Malaysian Government bonds maturing in Jun 2033. Enter the nominal value (in this case, RM 1000) and you’ll see:
Estimated Payment Amount (RM 1,225.60) - This is the amount you’ll be investing based on the bond’s current market price.
Estimated Yield to Maturity (3.091%) - This is the estimated annual return you can earn if you hold the bonds up to maturity (Jun 2033).
Estimated Coupon Payment (RM47.24) - This is the estimated return or so-called ‘interest’ you will receive annually.
Amount Received at Maturity (RM 1,000) - At maturity, you receive the nominal value of your bonds.
What are the risks involved?
Default risk. Bond issuers may declare bankruptcy and you could lose your investment. So, it’s important to pick financially sound bond issuers with good credit ratings. Check out ‘Investment Grade Bonds’ to learn more.
Interest rate risk. This applies if you want to sell your bonds before maturity. This video explains interest rate risk quite nicely.
How actively do I need to be involved?
If you intend to hold your bonds up to maturity, then not much follow-up is required. However, if you are keen to sell your bonds when the bond price increases, then you’ll need to keep an eye on price changes.
Bonds are usually considered safer than stocks (given that the bonds are investment grade).
They provide regular coupon payments.
There is also a clear-cut maturity date, so you know how long your money is being tied up.
Investment-grade bonds with high credit ratings may offer relatively low return. Low-grade bonds or ‘junk’ bonds may offer higher return, but also come with higher default risk. So, be sure to check out bond credit ratings assigned by rating agencies such as Standard & Poor's and Fitch.
Investors with lower risk appetite who prefer more predictable yield/return.
Platform that can be used
In Malaysia, Fundsupermart is a useful investment platform to trade both unit trust and retail bonds.
For readers in India, check out these resources:
On a side note…
I’m pretty risk-averse, so I like the idea of investing in investment-grade bonds; they’re relatively safe and provide predictable returns. However, such bonds may not offer exciting returns. For e.g. Malaysian Government bonds maturing in Jun 2033 offer an estimated yield to maturity of 3.091%, higher than current FD rates, but not very exciting.
As a rule of thumb, some suggest using ‘100 minus age’ to guide asset allocation. For example, I’m 28 this year, so 100-28=72, so 72% of my investments should be in equities (stocks or equity funds) and the remaining in relatively safer assets (government bonds, high-grade corporate bonds or bond funds). The idea here is that when you’re young, you can afford to take on more risk as you can make up for it over time. As you grow older, your investment portfolio should change to reduce your risk exposure.
Some even suggest ‘110 minus age’ or ‘120 minus age’ for those with higher risk appetite. This is primarily due to rising inflation and life expectancy; we need higher cumulative returns over our lifetime to sustain us in our old age. Risk-taking may be tough for some of you (as it is for me), but with research and patience, you can choose stocks that work for you. This of course is a topic for another day!