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July 6, 2009
Investing in Bonds Does Make Money
by Wong Weiyi
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Bond investing requires greater technical knowledge than equities. Moreover, in the stock market bull run of March 2003 to October 2007, global equities returned 137% or an annualised rate of 20.7%. Under such conditions, it is no wonder that when asked about bonds, investors will stare quizzically at you and ask, “Why would I want to invest in bonds? They can’t make money!" This brings us to the main point of this article – can bond investing make money? THE PREMISE Before looking at some numbers which help us establish if it is true that investing in bonds does not make money, it will be useful to discuss what we interpret from the statement. We observe that investors who do not invest in equities tend to keep their money in savings or fixed deposits. While these investments do generate returns, their primary purpose is that of capital preservation rather than generating returns. As such, these instruments are classified as safe, but viewed as investments that do not make money. In order to debunk the misconception that bonds like the above-mentioned assets do not make money, we need to see that historically, bonds posted returns higher than these assets. In fact, we think it will suffice to compare bonds with fixed deposit rates, which are higher than savings rates. We will look at past calendar returns over the years and see how the various bond indices compare with returns. Year Table 1 shows the calendar year returns of different bond classes since 1995. We can see that selected bond classes have returned double digits in the past. The highest returns came from high yield bonds which returned 35.1% in 1997. Year Table 2 compares the calendar year returns of various bond classes against the previous year end’s domestic fixed deposit rates and an “X” in the box indicates the bond class beat the domestic fixed deposit rates. We can see that investing in bonds tends to have a high probability of beating the returns that an investor gets from putting the money in fixed deposits, according to past statistics. From 1995 to 2008, investing in global high-yield bonds had a 62% chance of beating the returns from investing in fixed deposits. The probability is higher for global government and global investment grade bonds at 69% and 77% respectively. Table 2 shows us that investing in bonds has a good chance of beating investments in fixed deposits in Singapore. However, investors may still have doubts on whether bonds make money as it is not 100% certain that returns from bonds beat returns from fixed deposits. Let’s look at the annualised returns in Table 3. Annualised returns over 1995 to 2008 (in SGD) Table 3 shows the annualised returns of the various bonds classes and fixed deposits. If an investor had stayed invested in the various bond classes, the returns over the 13 years would have beaten returns from investing in fixed deposits. The outperformance of other bond classes is significant in Singapore’s context as Singapore’s fixed deposit rates are typically low and the annualised return over the past 13 years was only 2%. BONDS ARE RISKIER THAN FIXED DEPOSITS We have shown that investing in bonds is likely to beat investing in fixed deposits and that over our period of study, the annualised return is higher for bonds. We must state, however, that there is a difference in the risk characteristic between the two types of investments. Where much protection has been given to depositors such that depositors do not lose money, bonds investors do not enjoy such privileges. Investments in bonds are subjected to risks and Table 1 shows that investors can lose money when their investment timing is bad. In fact, in our study, the riskiest bond class – high-yield bonds – had plunged 26.7% (in SGD terms) in 2008. Before buying bonds as an alternative to fixed deposits, investors should take the time to understand the risk and return characteristics of various classes of bonds. (Read “Understanding Risks & Returns of Bonds”) CONCLUSION We have shown investors that returns from bonds do outperform fixed deposits and the annualised returns from investing in bonds over the long term (from 1995 to 2008) typically beat investing in fixed deposits. We hope these points are sufficient to dispel the myth that bond investing does not make money. That said, investors should understand that bond investments carry higher risk than fixed deposits. Investors should try to understand the risk and return characteristics of bonds before deciding whether bonds investments are suitable for their risk appetite. For Diversification, Bond Funds Still Warrant a Place in Your Portfolio | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||