Saving your money in banks will only earn you 0.3% to 1.2% interest per annum. Putting it on government or corporate bonds may earn you anywhere between 3% to 6% or more of passive income per year.
When should I invest?
Following the Pyramid of Wealth Accumulation, you should only invest when you already have enough emergency fund – which is 3 to 6 months of your current expenses. You should already have basic protection for your family in the form of life insurance, accident and disability insurance, and immediate education fund for your children if you have any. Investing should come after settling short term debts because most of the time interest rates from debts are much higher than interest rates from an investment. Once you have settled all these more immediate concerns, you are now ready to invest your “spare” money in different investment vehicles.
Ads
Never ever borrow money to invest. “Hey, I found this investment vehicle that gives higher returns compared to the interest rate from my loan in the bank.” If find yourself in this situation, most likely the investment vehicle is a scam! Think about it this way, why would companies borrow from you and pay you a higher interest rate when they can borrow themselves from banks?
Timeline and Risk Appetite
Knowing your timeline or investment horizon and risk appetite will let you make good investment decisions.
Timeline is simple, it answers the question, when do you need the money? Whenever we invest, there is always a purpose and timeline behind it. I am investing because I want extra income today to help with my expenses – short term. I am investing to buy a new car – short to medium term. I am investing for my children’s college education – medium to long term. I am investing to build our dream house – medium to long term. I am investing to make my money grow so I can live a comfortable retirement life – long term. Short term means less than 1 year, medium-term is 1 to 10 years and long-term is more than 10 years.
Ads
What about risk appetite? Are you comfortable with a higher probability of losing money in exchange for a higher probability of earning? If yes, you can opt for more risky investments. If you prioritize security over profitability then conservative investments are for you.
Bonds
If you invest in bonds, you are acting as a creditor lending money to corporations or the government. In return, you are given a fixed amount of interest given either quarterly, semi-annual or annual. If you invest 100,000 (the face value) and the declared interest is 6% (coupon rate) so you will get 6,000 interest, less tax (eg. 20%), so you will get a total of 4,800 per annum.
Once a bond reaches its maturity date, the creditor or investor is given back the full amount. Bonds are fixed-income securities as you can predict the total amount you will get at maturity. Depending on the terms, a bond investment can either be short, medium or long term.
Bond prices also fluctuate in the market. Similar to ordinary shares, the more the demand (with less supply) the higher the price. Bond prices tend to go high is inflation is low and low if inflation is high. This is because investors seek other investment vehicles with better returns to beat high inflation.
Why would governments and corporations issue bonds when they can borrow from banks? One reason is they are able to make interest rates lower compared to what banks will give them. Another is for diversification.
Government Bonds
Government bonds are almost risk-free investments since the chances or governments getting bankrupt are very slim.
Interest rates from government-issued bonds used to be high ranging from 7% to 12% or more but ever since the financial crisis of 2008, government bonds for most countries now average < 4%. Check out the historical rates (here).
Governments issue different kinds of bonds according to the timeline:
- Short Term (<1 year) = Treasury Bills (T-Bills)
- Medium Term (1-10 years) = Treasury Notes
- Long Term (>10 years) = Treasury Bonds
Corporate Bonds
Corporate bonds have a higher risk compared to government bonds but they usually give higher returns. Investing in corporate bonds will not make you part owners of a company unlike when you buy stocks but instead, you become a lender to the company. If the company closes down, lenders have priority over stockholders as they need to settle debt obligations first. The maturity date for corporate bonds depends on the issuer. It can be anywhere between 3 to 7 years.
Bonds, similar to stocks can be bought and sold after acquisition but not through exchanges but over the counter, usually in banks. You can start investing in government or corporate bonds by going to your local bank. Regularly check the business news section of your newspaper (or app) to know if there are new bonds being offered. You can also invest in bonds via mutual funds.
Terminologies
- Face value – the total amount invested in bonds.
- Coupon rates – interest rate of the bond.
- Maturity date – end of the contract, when the amount equal to the face value is returned to the investor.
- Rating – Letter grading indicating the bond issuer’s ability to pay.
- Zero-coupon bonds – bonds that do not pay interest buy sold at a discount. When maturity date comes, the bond issuer will buy it at a higher price thereby letting investors earn.
