Investing

Are bonds risk free?

Posted on April 27, 2008. Filed under: Investing |

 

Have you heard something like this – invest in bonds; bonds are very safe and is almost risk-free.

Well, it is true that bond is relatively safer as compared to equity investment, but it is surely not RISK-FREE. In fact, I have encountered many whom make the statement above not even know what is Bond in the first place.

It is essential that we understand the risk associates with bonds before we make our investment decision.

The risks associated with bonds are tied to several factors. There are interest-rate risk, credit risk, callability risk, and inflation risk. The safest bonds are short-term (less than 5 years) Treasury Bills followed by other short-term government bonds. The riskiest bonds are long-term bonds (12 years-­40 years), junk bonds, and high yield, or high return bonds.

a. Maturity period

The longer the maturity of bonds, the greater the interest rate risk while shorter term bonds have less risk but lower returns.

—Short-term bonds mature in 5 years or less.

—Intermediate bonds mature between 5 and 12 years.

—Long-term bonds have maturity dates of more than 12 years.

For eg, an investor choose to invest in a bond with 30 years maturity period. Within 30 years interest rates could change dramatically. If the bond pays 6% interest, and interest rates climb to 12%, chances are the investor could lose money to inflation and could be making more money elsewhere over 30 years.

This makes sense when you think about it. The longer a bond issuer is exposed to market or economic factors, the greater the odds are that something bad might happen.

b. Risk is also associated with the interest rate on the bond.

Bond with lower interest rates will experience more fluctuations in bond prices than bonds with higher interest rates. If you have two bonds maturing in 30 years and Bond A pays 5% interest and Bond B pays 15% in interest. Bond’s A’s price will change more dramatically than Bond B’s price. The principal value will have wider swings in its selling price if sold before the maturity date. For eg, if you own a bond paying 5% interest and you want to sell it one year later on the open market when the interest rate is 7%, you’re going to get a lower price than what you paid. After all, why would someonre buy your 5% bond if they could get a new 7% bond? The only way they will do it is by buying your bond at a discount.

Hence, it is right to say that bonds offer no hedge against inflation because inflation causes interest rate to rise which then causes bond prices to fall. Bond’s price can be quite volatile if market interest rates do vary after a bond is issued.

c. Ratings on bonds also reflect assumed risk.

Credit rating systems help consumers make more informed on the risk attached to each bond. Higher rated bonds carry less risk while lower rated bonds (e.g., junk bonds or high yield/high return bonds) have more risk.

Independent ratings services evaluate the credit risk of municipal and corporate bonds. These range from the best credit quality for issuers with the strongest financial status to the lowest ratings for issuers in default. Standard & Poor’s is one of the best-known ratings agencies. Bonds with S&P ratings of AAA, AA, A, and BBB are considered to be investment-grade quality. Bonds with ratings below BBB are considered to be junk bonds and are speculative.

Of course, the interest rate paid by these bonds go up as the risk rises. So, if a bond offers an interest rate that is way off the market, it is because there is a high degree of risk involved.

d. Bonds can be called.

Bonds may have call dates that protect the issuer from paying high interest rates if they can refinance and pay lower rates. If you hold a bond, it can be called back by the company issuing it. The company will pay you a predetermined amount to do this. Hence, you run the risk of having to reinvest your money at lower interest rates.

 

Hence, before making the decision to invest in bonds, understand clearly the associated risks. Make sure you read up on what their rating is. Try to stay away from the junk bonds even though they do offer a much attractive interest rate. And of course, try to stay invest for long term in order to minimize the risk. Bond prices may swing a lot if the bond is sold before maturity.  Investing in bonds are very much the same as any other form of investment in the sense that all require a certain level of knowledge to avoid disappointment…

 

Read Full Post | Make a Comment ( None so far )

Investment tips

Posted on April 24, 2008. Filed under: Investing, Uncategorized |

 Just some general tips on investment:-

 

1. Put a certain percent of our income towards savings, particularly long-term savings such as a retirement plan/child education planning. This will help ensure that you stay well ahead of inflation. For eg, if I were to invest RM1,000 per month for the next 15 years, with average rate of return of 8% pa, the future value of the invested sum would be RM340,000. Whereas if the same amount is being saved at normal saving account with minimum interest, the total saving by end of 15 years would be RM 180,000.

2. How do you decide whether you should invest directly in shares? Simple. If you haven’t got the time to learn about stock markets, to follow the progress of companies or to track your portfolio, rather invest in unit trust funds. 

3. If you do invest directly in shares, your two most important considerations should be ensuring that you have a properly diversified selection of shares across the stock market sectors to reduce risk, and regularly rebalancing your portfolio. When a share rises in price, you should consider selling some, but not all, of these shares, so that you make a profit, but your overall portfolio remains proportionally the same as it was when you started. By doing this, you’ll be able to reap further profits if the share price continues to rise.  

4. Generally, “savers” and “investors” have different objectives for their money. “Savers” plan to use their money in the next 3-5 years, while “investors” won’t need their money for five years or longer. Many “savers” want liquidity or quick access to their money without penalty. Then perhaps Bonds should be the choice. Bond provides a desirable saving or investment vehicle for many reasons. Bonds tend to be safer than stocks because if you hold bonds until the maturity date, you don’t risk the principal. Plus, bonds can provide a regular, steady source of income (typically, interest payments are received every 6 months). However, bonds tend to have a lower return than stocks over the long term.

5. If an investment product is too complicated to understand, avoid it. It does not mean you are stupid. It simply means that the product provider and/or financial adviser are trying to confuse you. You should not invest until you fully understand the product and the associated risks.

6. If you are a true investor, you invest for the long term and you don’t panic when markets fall. If you want to invest for the short term, you should use a bank fixed deposit or a money market account rather than an investment in the equity markets.

7. It is time in the market and not timing the market that counts. Don’t try to time markets. Few people have got rich from doing this and most have lost money. The best way to get rich is to take time to select an investment product that has properly diversified underlying investments, and then to stick with it for the long term. Most people make the fundamental error of buying into an investment when it is at the peak of its performance and then selling out when its value has dropped. I have made a few of these expensive mistakes. Believe me, it was painful!

8. Investing on a regular basis is a good strategy in volatile markets. If markets rise, your investment improves in value. If markets fall, you get more for your money, and you’ll benefit when markets go up again. This is known as dollar-cost averaging.

9. Don’t become emotionally attached to shares. If a particular share bombs out for good reason, such as bad management or failure to adapt to new markets, get out. But if the share value is falling as part of a general sector downgrade, there is little reason to sell. No wonder when Warren Buffett was asked how he became so successful in investing, he answered: “we read hundreds and hundreds of annual reports every year.”

10. If you are trading shares for short-term gain, you are not an investor, you’re a gambler. Don’t be surprised when you make a loss. Well, again, I am sharing with you my personal experience….

 

11. Being a contrary investor can make all the difference. As investment Guru Warren Buffett once said: “Be fearful when others are greedy. Be greedy when others are fearful”

 

12. Never invest on an ad hoc basis. You should have an overall financial plan designed to meet all your financial needs, taking into account your investment goals and life assurance needs. Investing in something simply because someone (friends, relatives, colleagues..) recommends it, is unlikely to help you achieve your financial targets.

13. Be prepared to pay for good advice, as you would for any expertise. But make sure you deal with an adequately qualified adviser. You are lost because you are not equipped with investment knowledge, so why go to someone for financial advice if that person is not properly qualified as yourself?

14. Always have an emergency cash fund. Ideally, the fund should be equal to three months’ income. This way you will not have to cash in investments at an inopportune time or take out a high-interest loan if you are suddenly landed with a major expense.

15. For regular saving, try to arrange your direct debit to channel money into investment as soon as after the pay day so that you will not “accidentally” spent away the money. Believe me, this is a practical advise!

 

Read Full Post | Make a Comment ( 2 so far )

Maximised return by market timing? See what Warren Buffett says..

Posted on April 20, 2008. Filed under: Investing |

When building an investment portfolio, we can use different strategies depending on our needs. Some strategies help us to increase our investment more quickly, while others may be more effective to reduce the impact of market fluctuations.

Generally, the earlier we start making regular contributions, the better off we may be. Not only will we have more time to accumulate wealth, we may benefit from compound returns on our earlier investment. This means we’ll not only earn interest on the money we contribute, but also on the cumulative interest earned on those funds; ie interest on interest.

Many investors think that the best way of investments is by timing the market, ie, buy low sell high. But, only few investors, if there are any, can accurately predict and time the market constantly. To me, timing the market is very much like gambling in Genting, sometime you win, sometime you lose!

Hence, time in the market is generally more important than market timing! Because the longer we stayed invested, we earn interest not only on the initial amount invested, but also on the cumulative interest that is earned over time. In short, the longer we compound, the more wealth grows. Compounding effect is very fruitful if we start early and make regular contributions.

There is a saying “that’s why the greatest investor is the most patience person in the world”

Leave you with the most respected investment GURU – Warren Buffett. We have a lot to learn from him.

 

 

 
 
 
 

 

 

Read Full Post | Make a Comment ( None so far )

Liked it here?
Why not try sites on the blogroll...