When Should You Consider Investing In Bonds (or Fixed Income Instruments)?
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Let's talk about investment bonds or other fixed-income instruments (i.e. fixed deposits) and when should you invest in them.
For those who are not familiar with bonds, it works like a loan (IOU) where you are “lending” your money in exchange for an interest return over a pre-defined duration. After the loan matures, you will get back your principal amount.
The thing about bonds is that while there is a higher certainty in the expected returns as compared to investing in stocks, the very expected return of investing in a bond had been on a decline over the last 2 decades as the central banks all over the world had continued to reduce their interest rates.
As a result, the viability of using and investing in a bond for your portfolio had essentially been decimated over the last two decades as returns plummet to such a low level that the instrument had lost its purpose as a diversification tool as compared to how it performed during the 1980s to 2000s.
That said, when should you invest in a bond?
The feasibility of using such a bond largely depends on the prevailing interest rate environment.
During times of a low or rising interest rate environment, investment-grade bonds should be avoided as investors are exposed to potential capital losses without being compensated adequately as the interest returns are low.
During times of high or decreasing interest rate environment, investment grade bonds should be considered as investors will stand to profit from potential capital gains while receiving a high-interest return.
Personally, I would not consider the use of bonds if their return rate is lower than the CPF Special Account (4%) as it does not make economic sense for us to take on a higher risk but be compensated with a lower return.
That said, there are additional considerations to be made before one blindly uses CPF Special Account as a bond proxy.
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Daniel is a Licensed Independent Financial Consultant with MAS and a Certified Financial Planner (CFP®).
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This article is meant to be the opinion of the author
This article is for information purposes only
This article should not be seen as financial advice
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