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Buy a bond fund that pays 7% a year?

Friday, March 21, 2014

UPDATED (December 2016):

In the last few years, I have been saying that we should avoid long term bonds and bond funds. Read comment dated 16 Dec 16 in the comments section at the end of the blog.
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A banker has advised a reader, K, that he buys into a bond fund. This was what K wrote in his email to me:

Hi AK,

i read your post and i like your advise on bonds. im currently unemployed and i need a steady form of income for my family.

A citi banker suggested that i buy a fund that is comprised of bonds that pays abt 7 percent an annum. 

please give me your opinion on such investment comparing to shares.  since its little fluctuation and it gives me income

thanks
K



My reply:

Hi K,

Too little information for me to make an informed decision, unfortunately.

However, if I were to hazard a guess, for a basket of bonds to pay you 7% per annum, I guess these bonds are not of investment grade. They could be "junk" bonds. Risk level must be higher which explains a higher return.

A 10 year bond issued by the Singapore government has a coupon of 2.75%. Singapore has a AAA credit rating, of course. More recently, CapitaMalls Trust issued a 7 year bond that has a coupon of 3.08%. Of course, lending money to CapitaMalls Trust is riskier than lending money to the Singapore government. So, although the period is shorter, the coupon is higher.

I would suggest that you ask for more information and not just look at the 7% yield which the banker says you will get.

When we buy bonds, we are lenders, not investors.


So, when we lend money to a business, what should we do? 

We want to study the business and the reason why they need to borrow money. Is the business strong and stable enough to pay the coupons and to redeem the bonds when the time comes?

So, what are the bonds which make up the bond fund? You should find out.

Best wishes,
AK


If you are going to buy a bond mutual fund, you have to be very careful because if interest rates go up, the value of that bond mutual fund will go down. And, in a mutual fund, there is absolutely not maturity date.


"So, what are you thinking? The worst thing you could do with your money right now is put it into a bond mutual fund." - Suze Orman (Read related post no. 1 below)

Related posts:
1. Nobody cares more about our money than we do.
2. A banker's advice on retirement income strategy.
3. CapitaMalls Trust: Buy the retail bond or the REIT?

20 comments:

la papillion said...

Hi AK,

The best thing about individual bonds is that they are capital guaranteed upon maturity. This means that you don't care about the price risk as long as you hold the debt till maturity. I doubt a bond fund is capital guaranteed. In fact, a bond fund will see its price go up and down according to interest rates. When you want to sell (there's no maturity date for bond fund, typically), you might even make a loss.

So while you get a diversified portfolio of bonds in a bond fund, you lose the greatest adv of getting into individual bonds. Hmm, worth it?

AK71 said...

Hi LP,

Personally, I wouldn't put my money in a bond fund.

If I were to park my money in bonds, in the current environment, it would have to be shorter term investment grade bonds, much like what you are doing with your parents' money, and hold to maturity. :)

Singapore Man of Leisure said...

Sorry guys,

Need to point out unintended poor england that may confuse newbies - there is no such thing as capital guaranteed bond.

Banks can offer "structured products" with capital protection guarantees, but they are not bonds.

Bonds can default - even sovereigns ones have been known to default, never mind those issued by corporations.

LP, I know what you meant. Not suffering capital loss due to rising interest rate by holding till maturity.

Once upon a time in 2008, some triple A rated bonds have gone belly up...

Which brings up another can of worms... Which ratings agency can you trust?

AK71 said...

Hi SMOL,

Thank you very much for weighing in on this. High quality comment, as expected from you. :)

Wait a minute! This comment from you is something rare! You don't usually comment in finance related blog posts here! More to come? ;p

Singapore Man of Leisure said...

AK,

Still dare to say!

I dying of thirst waiting for your next post on instant noodles, chocolates, and all things unhealthy but delicious (like nasi lemak) ;)

Tony said...

Hi AK,

I'm looking for high yield shares to replace REIT also. What do u think of CSE Global?

AK71 said...

Hi SMOL,

I just had a hot dog bun for breakfast this morning. Bought from bakery last night. Special offer because they were closing. 75c. ;p

Aiyoh, some people don't like me to blog about my junk food. I kena flamed never mind but my junk food kena flamed, all chaoda liao sayang lah. LOL. -.-"

AK71 said...

Hi Tony,

Firstly, ask why do we have to replace REITs in our portfolio? Are the buildings going the way of the Dodo? Will businesses no longer need to rent space?

Of course, if we feel that there are much better alternatives to invest in for income, then, yes, replacing could be a sensible option. :)

If CSE Global has no debt and is able to deliver the kind of yield which REITs are able to deliver on a sustainable basis. Then, it will be a better investment. A simple exercise for you. I lazy lah. ;p

Singapore Man of Leisure said...

AK,

Ooh baby... That's the spot!

I'm in raptures!


I think the food purists would squirm and remind you on what goes into a hotdog? I love luncheon meat bun! Twist and coil. LOL!


That reminds me of what I did in Tokyo - lurking at the supermarkets to buy discounted sushi and bread for supper and breakfast for the next day.

My place don't have bakeries that offer discount during closing...

OMG! What do they do with the unsold bread?

AK71 said...

Hi SMOL,

Tell you a secret. I bought 4 buns. I just had my second one. Shhh.... ;p

It has been a while since I had hot dogs because my niece told me they are unhealthy. Yes, I listen to my primary school going niece. I trust her. :)

Once in a while is OK lah, especially when it is on special offer! ;p

Hey, I do the same thing too. I always wait for the supermarkets to have clearance sale on sandwiches and bentos at 8.30pm in Hong Kong or Japan when I travel there. LOL.

If they don't sell them by closing time, I believe they are thrown away. :(

aceirus said...

Guys,

I believe most bread shops actually send them to old folk's or children's home. Throw them away so wasteful! ;)

AK71 said...

Hi aceirus,

I think some of them do. I don't know if most of them do. Would be interesting to find out. :)

boonchin.ng said...

Can buy some Breadtalk shares, attend their AGM and post the question on how they handle the unsold breads :)

Or AK already holding some Breadtalk shares? :)

EY said...

Hi AK,

I know Willing Hearts gets food donations like bread and get them redistributed to the poor and home-bound. I used to be a volunteer with them. Some of the other volunteers will help to collect leftover bread islandwide from those bakery shops willing to give away the leftovers after 9 or 10pm. :)

Back to the topic on bond funds. Thought it would be useful for your reader to find out more from Fundsupermart.com about the past performance of the bond fund and other bond funds. Just have to key in the name of the fund and do a search.

Good to note if it is CPF approved. That's one layer of safety that it is considered low to medium risk. But of course, we need to do our homework.

Something more credible like the 'NIKKO AM SHENTON SHORTTERM BOND(S$)' gives quite paltry returns. Might be good to use this as a benchmark for his consideration. :)

Info on the fund can be accessed from the link below:
https://secure.fundsupermart.com/main/fundinfo/viewFund.svdo?sedolnumber=370332

Cheers,
Endrene

AK71 said...

Hi boonchin,

Matthew Seah is a Breadtalk shareholder. Maybe, he has the answer. ;)

AK71 said...

Hi Endrene,

Thanks for all the information. I am more interested in what the bakeries do with their leftover bread than the bond fund! ;p

Matthew Seah said...

Hi boonchin,

BreadTalk stop baking around 2 hrs before closing. So what's left after the baking stops is what you can buy. The store at West Mall (near my house) usually has only a few bread left by the time they close so I think the employees just 打包 or throw away.

AK71 said...

Edwin Ng ZA: actually there are few instruments that can yield 7% perpetually. Perpetual are normally preference shares or equities. Walt disney 100year bonds can be one of them since the bond life out-live investor.

Basically REITs, bonds, preference shares or structure products. All mentioned contain risk & require certain understanding.

Alternatively, you can buy shares which can grow 7% per year. When you need money, sell off a portion of the shares. But please note, there can never be any guarantee that shares will appreciate 7% year to year even if the company is earning good. Some times it grow more, some times it goes under.

(Taken from FB)

AK71 said...

According to Carl Icahn, high-yield bonds are extremely risky but yet they are being sold “en masse” to the public, whom he believes don’t really understand what they are buying. The growth in the high yield bond market has been incredible, with the junk bonds and leveraged loan market now worth $2.2 trillion, up from $1.2 trillion five years ago.

Carl Icahn predicts that “if and when there is a real problem in the economy, there’s going to be a rush for the exits”. Investors who hold these junk bonds will find that there is no market for them.


Source:
http://www.sharesinv.com/articles/2015/10/05/4-dangers-icahn-is-worried-about-stay-away-from-bonds/

AK71 said...

Reader:
"... global asset allocation growth fund? Supposed to be having 7.2% dividend pa. However, I read from AK's post that a high dividend might not mean a good deal as the price of the fund might fall. Upon further research online, I also come across other articles which mention that the fund might just sell some of its units to produce dividends to pay the shareholders. Also of note will be the management fees. There is a 1.35% management fee. Meaning to say, if I were to invest $100k, straight away $1350 paid to the fund managers. There is also an initial 3% charge.. which works out to be $3k if $100k is invested."

AK:
"If they are investing for growth as the product name suggests, there is no way they can ever guarantee a fixed yield and a rather high one at that. If you are familiar with my asset allocation pyramid, you will know what I mean. After all the fees, you have to ask how are they able to give you a 7.2% yield. It might or might not be a bond fund but you might want to read this blog."

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