Following the wildly oversubscribed Temasek Bond, many may wonder when bonds are more preferable to stocks. This article will explain the key differences between the two, while focusing on the importance of investing according to personal comfort levels and risk appetites.
Investor type
Before delving deeper into the intricate differences between bonds and stocks, knowing what type of investor you are is important. An investor can be a mix of several investor types, and can tweak according to lifestyle changes and other economic factors.
Growth investors like to buy from relatively less prominent companies with a large potential in a bid to buy low and sell high. As such, low priced stocks that can be volatile are preferred to maximise their capital gain.
On the other hand, value investors dive straight into undervalued stocks to get them at a steal, and will sell them once the price adjusts back to its actual worth. A lot of analysis and evaluation is required to accurately determine the value of the company.
Passive investors will opt for blue chip and very stable stocks that do not require consistent monitoring. They tend to hold the stock and earn from the dividends and general growth. Good quality bonds can also form a large part of passive investors’ portfolio.
Stability of payouts
Unlike stocks, well rated bonds are comparatively stable and the returns are not as closely tied to the firm’s performance or profitability. It is not as volatile as stocks since price movement is comparatively limited. That being said, if the company makes resounding losses and is unable to turnaround, insolvency will be another problem. During insolvency, bond holders also have a higher priority to claim on assets. However, in other cases such as a company-wide restructure of cyclical downturn, the company is still legally obliged to pay coupons to bond holders. Needless to say, the regular payouts also provide a steady stream of passive income.
Preservation of Capital
Many deem bonds as a great alternative to depositing cash in a bank. While riskier than the latter, bonds is a means to guarantee the principal which may be useful for investors who are saving up for a large ticket item such as a new home, or further education. Stocks, on the other hand, does not seek to preserve capital as much as it seeks to build wealth. In uncertain economic times, capital preservation through good quality and highly rated bonds is all the more important as stocks may fall in price drastically during the period.
Extent of returns
Bonds are illiquid and not suitable for people who are looking for quick or drastic returns. It is also susceptible to the prevailing government interest rate. When the interest rate increases, bond prices decrease in order to compensate for the lower returns. Conversely, when interest rate decreases, bond prices go up.
Stocks are liquid and has the potential for huge gains or losses. It is much more sensitive to a plethora of economic factors such as company performance, market sentiments, speculation, and executive decisions, just to name a few.
More about bonds
- About Corporate Bonds
While many are well versed with how stocks work, not many understand corporate bonds. When you buy bonds, you are lending money to the company who issued you the bond. Such bonds can be issued by statutory boards or companies. Based on the credit rating, investors like yourself and gauge the extent of risk that you are about to take. Corporate bonds pay a fixed interest during the period that you are holding your bond.
Many Over-The-Counter (OTC) bonds in Singapore are sold in denominations of $250, 000 and may be accessible to accredited investors only. However, since 2011, some corporate bonds were made available on the Singapore Stock Exchange (SGX) and can be bought for below $1, 000.
- About the Singapore Savings Bonds (SSB)
Launched in 2015 by the government, this bond was recently oversubscribed in early 2018. This is an extremely low risk, with relatively decent returns given out every six months. The returns are deemed low when compared against ETFs and REITs. You are free to choose your investment period with no lock-in period and no penalty if you need to liquidate or withdraw. That said, the longer you lock up your money, the higher the returns, capped at 10 years. You can check how much you will get by using the interest calculator. For instance, if one puts SGD 5, 000 on Dec 2018, a total of SGD 1, 296 will be earned by Dec 2028, 10 years later, at 2.57% effective return per year. If the sum was taken out in Dec 2020 after only 2 years, the effective return per year drops to 2.04%, with SGD204 earned.
- About the Singapore Government Securities Bonds (SGS)
As explained, SSB rewards you with more returns the longer you hold the bond for. Conversely, SGS will pay you a fixed 2.78% interest on an annual basis if you hold it for 10 years. The minimum investment required for SSB and SGS is $500 and $1, 000 respectively. There is no investment limit for SGS, but SSB is capped at $100, 000. SGS is not as liquid as compared to SSB.
The same amount of interest rate will be paid out at the end of 10 years, but SSB will pay less in the earlier years and more towards the tail end. SGS, on the other hand, has a fixed payment. Considering inflation, getting money now may be a smarter choice than getting it in future. As such, if you are looking to have a fixed interest rate and intend to hold SGS throughout its maturity period, SGS may be preferable.
Conclusion
Having a well-rounded and diversified asset allocation strategy is key to financial freedom. On top of having bonds and stocks as discussed, properties, gold, and alternative investments should ideally be in the portfolio mix as well. This way, you will be able to spread risks across various asset classes during different economic times.
