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.

Fixed Income Products - Bank Deposit

What is your risk appetite towards investment? Are you so afraid to invest or are you willing to take some risk to improve your return on investment? Whether you are risk averse or a risk taker, there are products available in the market to suit your individual risk profile.

Today, I shall cover the safest investment options that you can go into to start growing your money and that is none other than bank deposits. Bank deposits are excellent investment options for emergency funds, capital preservation, and short term financial goals. These are practically risk free investments, that is you won't lose any money. However there is a trade off for that lack of risk and that is you don't get much return.

What is meant by "practically" risk free? It is risk free in the sense that you do not lose it in monetary term, but in term of its purchasing power, you will find that it declines over time. Why is that so? It is because of inflation. Inflation is associated with rising prices of goods and services. It is a condition in which too much money is chasing after too few goods. Hence if the interest you earn from the deposit barely covers the prevailing inflation rate, you would actually be losing buying power. So bear in mind that there is still a risk if you just leave your money idle in the bank.

Examples of bank deposits are saving deposit and time deposit.

Saving deposit is more liquid but has relatively lower interest rate than time deposit. It is liquid because you can draw it anytime you like. It is an excellent place to put your emergency fund.

Time deposit or certificate of deposit is not liquid compared to saving deposit because you are expected to let the bank locks up your saving for a period of time. Typically, you invest a fixed amount of money for a predetermined amount of time called the term, and you are guaranteed your principal plus a fixed amount of interest, which you receive either upfront, periodically, or at the end of the term. When the term expires, you can cash out the principal and interest, or roll over the deposit for another term. You can opt to withdraw the interest as they are received.

Time deposit or certificate of deposit can be purchased for terms ranging from three months to five years or more. Although interest rate is higher the longer you allow the bank to use your money, it is not a good idea to buy with term of more than five years. The interest rate situation could change dramatically during that time and you could get stuck with a long term, low interest rate deposit. As there is a defined date of maturity, cashing it in before that time will incur penalties.

In case you are not aware, saving and time/certificate of deposit are covered under the deposit insurance scheme in some countries.

For the risk averse, this is a good place to grow your money. For the risk taker, it has a place in your investment portfolio too as it helps to spread your risk. Very important though, you must make sure that the deposit interest rate is higher than the inflation rate. Also, bank competes for deposits by offering better than average rates. It is advisable that you shop around to find banks that offer the highest yield possible on your deposit.

Remember, there is still risk if you just keep your money idle in the bank. Give your money the opportunity to grow for you.

Ways to Invest

Have you started saving for your emergency fund? I encourage you to do so if you have not. For those who have already reached the targeted emergency fund, I congratulate you. This means you are ready to invest.

There are a number of ways that you can invest in the financial markets. As an investor, you would want to make the right investment choice that best suits your financial needs. Hence, you must take charge of your own investment.

As a start, you should get yourself familiar with the different types of investment instrument available in the financial market. The common ones are:

a) Bank Deposit
Bank deposits like fixed deposit accounts are usually short term investments to hold money for use in the near future. It is easily convertible to cash. Such deposit has low risk of losing value but offer low potential returns.

b) Insurance Products with savings or investment element
These are product that provide not only protection but also a saving or investment plans. Examples of these are whole life polices, endowment polices, annuities, and investment linked insurance policies.

c) 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 and the bonds value appreciate or depreciate in relation to interest rate changes. This is generally a safe investment. However, except for bonds from the government, bonds carry the potential risk of default, no matter how remote that risk might be.

d) Structured Deposits
A structured deposit is essentially a combination of a deposit and an investment product where the return is dependent on the performance of some underlying financial instrument. Typical financial instruments linked to such deposits include market indices, equities, interest rates, fixed income instruments, foreign exchange or a combination of these.

e) Mutual Funds / Managed Funds /Unit Trust
A mutual fund is an investment company that takes cash from investors and invest it into diversified securities, providing investors with both diversification and professional management of their funds. A mutual funds invest in stocks, property, bonds, options, money market securities, and commodities to name a few, depending on the fund's investment objectives.

f) Shares and Equity
Stock investment is equivalent to holding an ownership in a corporation, and your investment value appreciates as the price of the shares or equity goes up and vice versa. This is considered a high risk investment, unless you managed it well with great discipline.

g) Option Trading
An option is a contract between two parties giving the taker (buyer) the right, but not the obligation, to buy or sell a security at a predetermined price on or before a predetermined date. To acquire this right, the taker pays a premium to the writer (seller) of the contract. There are two types of options available: call options and put options. Call options give the taker the right, but not the obligation, to buy a security at a predetermined price on or before a predetermined date. Put options give the taker the right, but on the obligation, to sell a security at a predetermined price on or before a predetermined date. The taker of the put is only required to deliver the underlying shares if they exercise the option.

Above are just a brief account of what they are. You will get more details in due course. So stay tuned.