Investment- Understanding Bonds and Equities
Updated: Apr 13, 2022
Bonds and equities are two of the many investment products available in the market, and it is considered as the more popular investment options for most investors. Despite the similarities between bonds and equities, there are slight differences between these two. For instance, equities refer to shares issued by public companies on the stock market while bonds refer to securities issued by the government or companies. Equities are usually sold through brokers on various exchanges, and it is sold in a centralized location. Several exchanges which have a larger portion of shares traded include New York Stock Exchange (NYSE), NASDAQ, and Hong Kong Stock Exchange. On the other hand, bonds are sold Over-the-Counter (OTC), in a decentralized location.
Bonds in Singapore
The bond market is commonly known as the debt market. Securities that are sold in the debt market are considered to be companies looking for lenders to borrow a certain sum of money. In return, securities’ purchasers will receive interest on the amount “lent” to the company.
In Singapore, there are three types of securities offered by the Singapore government – Singapore Government Securities (SGS) Bonds, Treasury Bills (T-Bills), and Singapore Savings Bonds (SSB). To plan your purchase of these bonds, check out the auctions and issuance calendar here. Additionally, there is no capital gain tax in Singapore; this means that there will be no tax on interest earned on the three securities offered by the government.
Singapore Government Securities (SGS) Bonds
SGS bonds have a maturity from 2 to 30 years. This bond has a fixed interest rate that is payable every 6 months; and the minimum investment amount is $1,000 SGD. Individuals who wish to purchase SGS bonds can do so via cash, CPF Investment Scheme (CPFIS) Ordinary Account or Special Account, or Supplementary Retirement Scheme (SRS).
There are two types of T-Bills issued by the government – 6-month and 1-year T-bills. These bills are short-term securities issued at a discount to the face value. Upon maturity of the bill, investors will receive the face value of the bill. Similar to SGS bonds, T-bills can be purchased through cash, CPFIS, and SRS. The minimum investment amount in T-bills is $1,000.
SSB is offered every year and it allows individuals to invest in it for up to 10 years, starting from a minimum of $500. The return rate of SSB increases the longer you hold on to your bond, with no penalty for redeeming it earlier. Investors can invest in SSB through cash or SRS.
Unlike bonds, equity holders are not lending their money to the company. Instead, they are purchasing stakes in the company on the confidence that it will perform in the future, leading to an increase in equity value and eventually their profit from it. In the stock exchange, buyers and sellers of shares and equities have a regulated platform to transact, giving investors the confidence that the exchange is transparent and reliable. Most investors tend to use S&P 500, or STI for local context, to gauge if the market is performing well.
Risks of bonds and equities
In general, equities and stocks have a higher risk than bonds. This is especially so as equities are exposed to various types of risks, such as liquidity risk, currency risk, and geographical risk. Liquidity risk comes about when the company is unable to convert their assets into cash to fund their operation; while currency risk refers to the foreign exchange rate during investment. For example, if one is keen on investing in a stock on a brokerage platform, the platform might not accept SGD as a currency of investment. In this case, the individual will have to exchange for USD or CAD to make the investment.
On the flip side, bonds, especially government issued bonds, are less risky as there are only two main types of risks involved – interest rates and inflation. The risk on interest rate occurs when interest rate rises, leading to a drop in the price of bonds. In most situations, the increase in interest rate goes hand in hand with inflation. During inflation, investors might need to sell their bonds for cash. This will result in a negative profit as the selling price of bonds are lower than purchase price.
Types and returns of equities
There are three main categorizations of stocks and equities – growth, value, and dividend (a.k.a. income stocks).
Investors of growth stocks look beyond the undervaluation of company shares; they look at the unrealized potential of the company. These stocks are usually held for a minimum of 3 years, with a potential for the highest return out of the three. However, growth stocks carry the highest risks among the three.
Value stocks come about when investors discover an undervalued stock and hold them for a period of time, till the value increases for a substantial amount. These stocks are usually from smaller scale companies which have yet to be discovered by the general mass of investors. Similar to the growth stock, value stocks tend to be held for at least 3 years to allow investors to see the returns.
Lastly, the main goal of purchasing dividend stocks is to generate a steady stream of return for the long-term. In the best scenario, the dividend payouts will be higher than those of insurances with payouts. Unlike growth and value stocks, dividend stocks do not require investors to hold on to it for a long period of time and it is less risky as these companies are generally more stable.
Returns of bonds
With reference to Singapore Savings Bonds (SSB), the average return rate over the maximum investment period of 10 years is 1.78% (for January’s SSB). Comparing it to the average return on equities of 10%, the bond is not generating a high return for investors. With that in mind, it is also important to understand that the higher the risk, the higher potential for more return. As such, equities and stocks will have a higher return as compared to bonds.
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