Risks in Bond Investment

Despites its conservative nature, Bond investment has risk too. As an investor. you should be aware of the degree of risks you carry in order to invest prudently.

Bonds can be subject to credit risk. This is the risk of default which means that the issuer is unable to pay the interest or the principal of the bonds to the investor. Hence it is important that you find out the credit rating of those corporations that you intend to invest in. You may refer to rating agencies like Moody's and Standard and Poor's to determine the credit worthiness of corporations and governments. Government Bonds are fully backed by the full faith and credit of the government. As such, the risk of default can be little or negligible

It is not necessary to hold bonds till maturity. There is a secondary market where bonds can be sold before it matures. However, you will be subject to interest rate risk if you do so. As you have learnt in the earlier post, bond price can fluctuate due to changes in interest rate. In fact, a bond price has an inverse relationship with interest rate. This means that if interest rate rises, bond price will decline and vice versa. If you were to sell a bond before it matures and the price has fallen, a part of the prinicpal investment would be lost together with any future income stream. Generally, bond investors are more concerned with receiving income instead of capital appreciation, and principal investment at maturity.

Due to its safe and stable nature, returns from bonds are generally lower than high risk investment like equity. In an inflationary environment, the total return may not keep pace with inflation. Hence you may be subject to inflation risk. This means that though the return is postive, you may actually see a decline in investment in real term.

Lesson to be learnt:

Never put all your eggs in one basket. No one investment is totally safe and that includes fixed deposit because you would not be able to hedge against inflation. Diversification is the way to go to grow your money.

Other Topics:

How to set Goals? Click Begin with an end in mind,

Importance of Saving: Click Power of Compounding, Power of Saving,

How to grow my wealth? Ways to Invest

Uses Of Bonds

As you have already learned, bond investments are interest earning and its value can appreciate or depreciate in relation to interest rate changes.

Bond is generally a safe investment. However, except for bonds from the government, bonds do carry the potential risk of default, no matter how remote that risk might be.

Bonds would appeal to those who want to receive interest income or to preserve and to accumulate capital. If you want regular returns of a certain amount of money, a bond will fit the bill very well.

Bond is a better alternative to savings and fixed deposits. If you wish to invest your money safely for a longer period of time, bonds serve this purpose better than fixed deposits. You can beat inflation and enjoy higher returns than fixed deposit rates.

Due to the conservative nature of bonds, it is one of the investment tools that could be added in any phase of your retirement portfolio. Your holdings in bonds would vary depending on your risk tolerance and investment time horizon.

If you are young and have many years away from retirement, you are most likely to build your nest egg by taking a fairly aggressive stance. However, it would be unwise to put everything into equity as it is a very volatile instrument and are generally the most risky. You would probably have a diversified investment portfolio that consists of bonds, equities and cash in varying allocation. Diversification offers some protection for your portfolio as the rising value of certain assets could help to offset the assets that are facing a negative impact. By adding bonds in an equity portfolio, it would enhance stability and reduce risk exposure as your capital in bonds would likely to be protected from equity market fluctuations.

If you are a few years away from retirement or have retired, you need to protect yourself from possible steep equity declines. You can shift from an aggressive stance to a moderately aggressive one by adding more bonds. As you receive a fixed amount of income that is paid regularly over the lifetime of the bond, the predictable cash flow from bond investment adds a necessary element of stability to the retirement portfolio.

As lower risk often leads to lower returns, the emphasis of investing in bonds generally does not lay in capital appreciation, but in, income generation and capital preservation. If you invest in bonds of good credit ratings, you will most likely get back your principal upon maturity. As it is possible to incur a capital loss if you were to sell before the bond matures, you will need to consider when you want the principal to be repaid and the kind of returns you seek, and take into account your risk tolerance.

Bonds - Fixed Income Instrument

Having talked about bank deposits and forced savings through insurance product the past few weeks, today I shall cover another investment instrument that one can consider and that is Bonds.

What is Bonds?
When investing in bonds or fixed income/debt securities, you are actually lending money to finance a corporation or the government's operation, becoming a creditor of the corporation or government.

Bond investments are interest earning. It has a coupon rate which is the interest earning element and a maturity date. During the initial issue, a bond is sold at par value, or 100% of its face value, and the return (yield) is the coupon rate. Once a bond is issued, the coupon rate or interest is fixed and will not change throughout the term of the bond. However the price of the bond will change. This is because bonds can be bought or sold on the secondary market before they reach maturity. There is hardly a time when a bond is sold at par value. When a bond sells below its par value, it is said to be selling at a discount. On the other hand, if it sells above par value, it is selling at a premium.

A change in the price of the bond is caused by changes in interest rate. When interest rate rises, bond prices will depreciate. This is because new bond issues will have higher coupon rates than existing bonds. Therefore, bond prices will fall to compensate for the difference between the existing yield and the current market yield. Hence, an investor considering the purchase of the existing bond can earn additional interest by paying less (< $1000) for each bond and getting the same coupon rate. The opposite is true when interest rate in the market falls and new bond issues offer a coupon rate that is lower than the existing coupon rates. Bond prices will increase because whoever buys the bond at par value would be earning a coupon rate that is higher than market rate. This will result in excessive bidding for the bond due to its attractive yield. The price of the bond will then be bid up to the level where the bond offers a comparable yield as the current market yield, usually higher than the par value.

In summary:
When bond is sold at par, return = coupon rate;
When bond is sold at discount, return > coupon rate;
When bond is sold at premium, return < coupon rate

Henceforth, when investing in bonds, not only will you earn interest but also get the opportunity to sell at a premium when bond price increases. You can also choose to hold it till maturity should bond price decreases.

Retire? Not so soon, say many Singaporeans polled

Below is an excerpt from an article taken from the Straits Times dated August 11, 2007.

Retire? Not so soon, say many Singaporeans polled.
"Singaporeans are in no hurry to retire and most want to work beyond the official retirement age of 62, some even into their 70s. It is a case of "CPF not enough" for many of these workers.

Seven in 10 polled last month in a Straits Times Insight survey on CPF said they do not think their savings in the national pension fund will see them through old age.

The survey of 636 Singapore residents aged 30 and above found that apart from CPF, 77 per cent expect to be able to draw from other sources of retirement income, mainly savings, investments and insurance. But a significant minority of 23 per cent had nothing else set aside.

One cause for concern is that only one in two Singaporeans has done any financial planning for retirement.

Even fewer, three in 10, have done their sums on how much they need to squirrel away.

What may mitigate against any resulting savings shortfall is their willingness to work beyond the retirement age of 62."

Hi Friends,
Where do you think you stand in this area? Do you have a sense of security over your retirement finances? Would you be happy with just a lifestyle of S$789 per month when you retire? If not, are you willing to work beyond your retirement age of 62?

These are real issues that one cannot ignore. At the national level, our government is studying ways to tackle the ageing population and one of the ways is to help Singaporeans work longer.

Which do you prefer?
a) I need to carry on working because of worries over insufficient savings; or
b) I like to carry on working because it adds meaning to my life.

I believe everyone wants to be given a choice. And who can give you this choice? It is yourself. So start planning early for your retirement. Grab a copy of the financial plan template to get an insight on how to do your financial planning for retirement.

Insurance Policy as a Savings Vehicle - cont'd

Essentially, there are two types of non-participating and participating policies for your saving needs. They are:
a) whole life insurance;
b) endowment insurance;

Whole life insurance is a permanent insurance policy. It provides insurance coverage for the entire life of the insured. This means to say that as long as premiums are paid, the coverage continues until the insured dies or reaches some predetermined advanced age (usually 100 years old).

Whole life insurance policy has the following common features:
a) It covers the insured against death; Duration of cover is for life;
b) It also has some form of saving element known as "cash value". This means that the insured can encash the policy by surrendering it after a specified period of time (usually three years);
c) policy lapses if premium is not paid witin the 30 days grace period. However that can be avoided, if policy has acquired a cash value, by activating the non-forfeiture options like surrendering the policy for its cash value or converting it into a reduced paid up policy or extended term insurance policy;
d) policy loans are allowed once the policy acquires a cash value. It is borrowing against the policy's cash value and interest is chargeable;
e) premium is usually a fixed amount payable on a regular basis; It is higher than term insurance.
f) death benefit is payable in one lump sum upon death;
g) total and permanent disability benefit is usually attached and is paid either in a lump sum or in instalments upon total and permanent disability;


Endowment insurance is also a permanent insurance. It has a fixed maturity date which is typically ten, fifteen, twenty years up to a certain age limit( e.g.65).

Common features of such insurance policy are:
a) Duration of cover is for a period specified at the inception of the policy. When this period ends, the cover stops and if the insured is alive, the maturity value ( the basic sum assured + bonus, if any) will be paid to the insured;
b) cash value builds up quickly;
c) non-forfeiture option is available once policy acquires a cash value. Hence insured can avoid having the policy lapses which is possible if premium is not paid within the 30days grace period; d) policy loans are allowed once the policy acquires a cash value;
e) sum assured, plus bonus if any, is paid in one lump sum upon death;
f) a total and permanent disability benefit is usually attached and the sum assured, plus bonus if any, is paid in instalments upon total and permanent disability.
g) premium is a fixed amount payable on a regular basis. It is higher than Term and Whole Life Insurance policies.

I hope you have obtained some good understanding of the above policies by now. These are useful saving vehicles that you can consider. Building a retirement fund is a long haul process. You have to start saving early and investing it over a long period of time.

Insurance Policiy as a Savings Vehicle

Do you have problem saving up? Read this if you are one of those who have no discipline to save.

The saving tips that I am about to share with you is a Forced Saving Program through the use of insurance policy.

Life insurance as a useful savings vehicle can come in two form:
a) non-participating policy with cash value
b) participating policy

A non-participating policy refers to a life insurance policy that does not share in the profits of the insurer i.e. the policy-owners of such products are not entitled to any bonus payment by the insurer. Such products are also known as without profits policies. Only non-participating policies that acquire cash value has a savings element. Term insurance is also a non-participating policy but it is purely for death protection purpose and does not have savings element because it does not acquire cash value.

Participating policies, on the other hand, refer to life insurance products that share in the profits or surplus of the insurer. Such products are also known as with profits policies and the policy owners receive bonuses from the insurer. The bonuses are declared on an annual basis and are guaranteed once they have been declared. Participating policies acquire cash value too.

What is Cash Value? Cash value (also known as "Cash Surrender Value" or reserve) is the amount of money, before certain adjustments, that the policy owner will get in the event that he surrenders his policy to the insurer for cancellation. Cash value arises as a result of the level premium system adopted by insurers. During the early years of the policy, the premium paid covers more than the cost of insurance protection provided by the company because the risk that the insured will die is lower. In the later years of the policy, the same premium covers less than the cost for the insurance protection by the policy as the insured grows old and is more likely to die. The extra premium collected in the early years by the insurer is set aside partly to form the policy's cash value. As time goes on and premiums continue to be paid, the cash value grows.

A word of caution: Most of these policies don't start to build decent cash value until their 12th or 15th year. Usually, it will breakeven on the 10th year i.e. total premium paid = cash value accumulated. So if you surrender in the first five years or so, practically most of the money you put in will be down the drain. Hence, if you buy one, be prepared to pay into it for a very long haul to yield a reasonable return for your retirement. Otherwise, I think you should just forget about it.

Surplus from the participating policies is the amount by which the insurer's assets exceed its liabilities. Surplus usually arises from:
a) bonus loading on participating policies;
b) the profits made by the insurer from all classes of business

Returns from these policies are usually in the range of 3 to 5%.

Forced Saving Program

Do you have the financial discipline to save? If you don't and if you always find that money is not enough, you may want to consider taking a forced saving program to ensure that your retirement funds are well provided for in your golden years.

The forced saving program that I would like to introduce here is an insurance product with savings element.

Life insurance, namely, Whole Life and Endowment Insurance are useful savings vehicles. These policies acquire cash value over the years which the policy owner can tap for various purposes such as taking a policy loan or surrendering the bonus to meet some urgent needs. In addition, if it is a participating policy, it pays annual compound bonuses on the policy which are tax free. Such policies enable the policy owner to enjoy capital growth on their investments.

As the name implies, Whole life product is designed for a longer term and perhaps for your entire life. Premium payments purchase protection against the risk of premature death and also allow you to build a cash reserve -- the savings element.

Generally, the face amount of the policy and the annual premium are fixed and the cash value of your policy increases, so the amount of pure risk protection decreases over time. You could look at a whole life policy as a combination of decreasing term life insurance and an increasing savings fund. Part of your premium goes for the death benefit and the rest is like an addition to an investment account.

Also be fully aware that, unlike a savings account, the savings element of a life insurance policy is usually not immediately available to you. You may have to pay surrender charges if you withdraw funds early in the life of the policy. You should carefully consider how much you are paying for the "savings" part of the policy and how soon you might need these funds.

I will elaborate more about the products in the next post.