Assuming that you intend to invest in some fixed income instruments to diversify away risks, bonds are one consideration. Then how to decide whether to invest through a bond fund or through direct ownership of bonds?

This is like whether to hold individual stocks or to invest through a so-called professionally managed mutual funds/unit trusts.

You can look at the following table here for a quick comparison for the plus and minus of holding bonds through a bond fund or directly,

http://personal.fidelity.com/products/fixedincome/considering.shtml

Basically, the first criterion is how much you have to invest in the first place. Corporate bonds usually need sold in $5000 face value and they are usually sold in blocks of 15 bonds, just like shares are usually sold in lots of 100 shares, 1000 shares etc. As you can see, a high capital is needed just to buy 15 corporate bonds of the same company with triple As ratings and without diversification.

Although in general, a newly issued corporate bond cost $5000, but to achieve adequate diversification, one needs to hold bonds across different sectors and issued by different corporations and coupled with the fact, one does need substantial capital of at least $100 000. Other disadvantages include having to educate yourself completely on all the other aspects of bond investing.

This is clearly not economical for those with less than $10 000 to invest in bonds directly. There is no diversification, unlike a bond fund which holds a basket of many bonds issued by quite a number of corporations. This is in addition to, unlike equities, where $10 000 can already hold many distinct stocks, $10 000 can at most hold two bonds from two different companies but there is limited capital appreciation from bonds but high risk, whereas diversifying the same $10 000 into small cap stocks can return higher capital appreciation with slightly lower risk.

Of course, the most risk free way to invest in corporate bonds is to buy very high investment grade ones (for example, those issued by General Electric) and then hold on to maturity so that you can guarantee to earn the yield to maturity, that is provided the corporations issuing the bond did not default on their bonds and should they defaults, don’t have enough assets to pay back the loans from issuing the bonds.

The key question is, should you have substantial capital and decide to choose between bond funds or direct ownership of bonds, which should you choose?

Bond funds as with mutual funds for equities will got many and high expenses like sales load, management fees, among many others. Before there is any return, one already makes a lost on the many fees being charged.

This is where investing in bond funds (holding corporate bonds) may bring not much greater returns than risk free fixed deposits and treasury bonds.

Bond funds generate returns in two ways, one is coupon payments, and another is capital appreciation in bond prices. If you add up all the fees in percentage terms and subtract from interest payments in percentage also, what did you get?

Let us look at capital appreciation from bond prices, in general, when interest rate rises, bond prices fall and vice versa. As a result, you stand a higher chance of making higher positive returns from bond funds if you enter when the interest rate is already very high and unlikely to rise further.

As for direct ownership of bonds, one has to track and buy individual bonds so as to buy below face value. One must know that there is still volatility in bond prices and the best and effortless way to invest is to buy at below face value and then hold on to maturity and earn the yield to maturity so that can save the trouble of having to look at the computer screen for daily bond prices. (Assuming that you did not invest in junk bonds in the first place)

As with individual stocks, this involves educating yourself thoroughly about bonds. There are many factors that determine bond prices, the main factor of which is interest rate as mentioned above.

The conclusion is that if one has a sum above US$400 000 do not restrict yourself to just bonds and bond funds for stability. There are still boring utilities stocks whose share prices do not drop too much even during a prolong bear market. In addition, there are constant dividends arising from their fairly constant revenue as people still need the services procure by them during a recession or bear market.

If the demographic profile within a certain geographic area shows promising returns in rental income, investing in properties for rental income is also a better choice than bond funds.

Related posts:

1. Bonds will be a big loser if invest for long term
2. Neglected risk when invest in stocks and bonds through mutual funds and ETFs
3. Is investing in POSB’s MyHome Fund wise?

According to local mainstream media in Singapore, there are three funds options. The POSB’s MyHome Fund buys into DBS Singapore STI ETF and ABF Singapore Bond Index Fund.

Let us look at what the DBS Singapore STI ETF and ABF Singapore Bond Index Fund consisted of, based on what the newspaper say, the two funds invest into the following, as you can see the equities portion is already a much diversified portfolio of stocks listed on Singapore Stock Exchange.

DBS Singapore STI ETF = buys into Singapore Shares (a diversified portfolio consisting of companies listed on Singapore Stock Exchange)

ABF Singapore Bond Index = buys into Singapore Government bonds (only? Without other corporate bonds?)

The POSB’s MyHome Fund consisted of three options,

1. HomeSteady portfolio = 80% in the ABF index and 20% in the STI ETF

2. HomeBalanced portfolio = 50% in the ABF index and 50% in the STI ETF

3. HomeGrowth portfolio = 20% in the ABF index and 80% in the STI ETF.

There are four simple reasons why investors will be better off buying directly into the funds that the fund invested in.

1. Stability of returns

The return of STI ETF in the long run depends essentially on two main factors, the increase in productivity and inflation of Singapore.

The return of ABF Singapore Bond Index depends on Singapore government bonds only and in turn depends on the reserves and social-political-economic stability.

2. Basically no diversification for ABF index

I don’t understand why there is even a need to pay an initial 3% of sales charge (not 0.3% as reported in newspapers) and annual management fee of 0.5% when you may as well directly buy into the Singapore government bonds at the same bank and ATM machines.

3. No difference between placing money in local and foreign banks in Singapore and buying into Singapore government bonds

In the sense that both fixed deposits and returns from Singapore government bonds are guaranteed and backed by the massive reserves. If you see savings and fixed deposits in local and foreign banks in Singapore as risk free, then buying into Singapore government bonds is essentially the same as risk free also.

There is no need to invest through a bond fund when all of the bond’s funds are invested in one financial instrument. It is like investing in a mutual fund that consisted only of one company stocks and you still pay all the purchase fee, management fee, load fees, etc. Why don’t you may as well own the stocks directly?

There is no doubt that buying the HomeSteady portfolio is short changing yourself by paying the initial 3% of sales charge and annual management fee of 0.5% for nothing, with 80% invested in ABF index.

As a result, there is no need to invest through a bond fund for safety through diversification.

4. DBS Singapore STI ETF is already a diversified portfolio of stocks

Seriously speaking, one should just buy into STI ETF directly rather than through POSB’s MyHome and add another layer of cost totally for nothing. Given that most investors will be for long term, a better way to achieve higher returns is simply once the STI index falls below a certain value, start to dollar cost averaging into buying and totally stop buying once STI index rises above a certain value. (Simply kept cash in savings account when STI index is too high, wait for the value to fall).

What is the conclusion?

Singapore investors will be better off buying into DBS Singapore STI ETF and Singapore government bonds directly (NOT ABF Singapore Bond Index which still got higher costs than directly buy and hold Singapore government bonds through online brokerage)

You are simply paying the 3% of sales charge and annual management fee of 0.5% for almost nothing. Quite an easy way to make money for the bank involved, it is clear that there is no need to hire another first class honors as fund manager to manage the fund.

If there are significant people buying into POSB’s MyHome Fund, a better way is to invest in DBS bank shares (POSB bank is wholly owned by DBS bank and provided if the price is right) as this fund is really a good way of increasing the profit margins of POSB bank.

In short, if you have $10 000 and want to invest $2000 in ABF Bond Index Fund and $8000 in STI ETF and, you can buy into these two directly with lower costs, no need to buy the HomeGrowth portfolio and lose 3% of sales charge and annual management fee of 0.5% immediately.

Moral of the story,

Finance companies, insurance companies and banks are not benevolent donors to your wealth. The most important fact in growing your hard earned money is really more financial literacy and not paying unnecessary expenses for nothing.

Related posts:

1. Is it wise to invest in bonds through bond funds?
2. What is a good index for index investing?
3. The right way to measure mutual fund performance

To recap, bonds are simply IOUs issued by governments and major corporations listed on stock exchanges. They are loans to you, as an investor, make to them in exchange for getting your principal back, along with regular and periodic interests payments every quarter or biannually.

Coupon of bond = interest of principal paid each year. Image Credits: lilivanili
For instance, a bond with a 10% coupon rate and principal sum of $1000 will pays you an annual amount of $100.

Here are a few reasons why investing in bonds for long term is a sure lose event, second only to savings account. The enemy is inflation. In other words, the bond income alone decreases in value by more than 50% as in purchasing power assuming that it is redeemed at maturity 20 years later, and assuming inflation is 4% on average each year.

1. Coupon payments are fixed in absolute dollars amount throughout the whole life of the bonds.

This by definition already means that it will not keep up with inflation even if the bond issuer did not default.

2. The principal sum used to purchase the bond, for example, $1000, will also be the sum used to purchase back the bond by the issuer.

The $1000 after more than 20 years never appreciates in value. Assuming that inflation averages 4% per year, the $1000 is worth only $460.40 20 year later.

3. Bond prices are really not stable compared to stock prices.

Bond prices are affected mainly by interest rate, among many other factors, which resulted in volatility in bond prices. As a result, bond prices are nearly as volatile as stocks.

Related posts:

1. Is it wise to invest in bonds through bond funds?
2. Neglected risk when invest in stocks and bonds through mutual funds and ETFs
3. Are you aware of what your mutual funds own?