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?