Bonds Versus Equities

People who plan for others should be aware of what they are doing and what they are planning. I have someone (a financial advisor who has been at his position for the last 8 years) who told me that bonds are the safest bet today after what has transpired globally over the last 2 years. He told me that equities are all bad for someone who doesn't want to lose money. In short, put all who are fearful of losing money in the short term into bonds. Let's take some time to analyse this shall we?...

A bond is actually a debt instrument whereby a company or even the government of a certain country takes up a loan from the public. The bond usually consists of some interest payments over the course of the bond period and at the end of it the whole principle sum will be repaid.

Example:
A bond that costs me $1000 (face value) with interest (coupon payments) of 2% per annum (ie. $20 will be credited to me every year) for 10 years. At the end of the 10 years, my $1000 will be returned. If there is a wish to sell off the bond before maturity, one can do so but the market will take the bond in at what it deems accurate (Example below).

HEADLINE NEWS (If you're still living in a turtle shell)

1) Interest rates are SUPER low. In the near to medium term they will head up! I can get a housing loan today with current rates of 1.6% interest per annum. Lower than what HDB has to offer.

2) The world is inter connected to the US market. When the US market sneezes, we get a cold. Currently there is much talk about the Federal Reserve in the US raising the interest rates to combat a devaluing currency and to stop this artificially low interest rate environment.

Lets take a look at what will happen

Fearful of losses client purchases a bond with face value of $1000, interest rate is at 2% per annum and thus will receive $20 every year. This bond will mature in 10 years and at that point in time his $1000 will be returned to him.

2 years down the road, interest rates WILL have risen to perhaps 5%. At that point in time a similar bond with 10 years maturity and 5% interest will also cost $1000 but then will return $50 every year till it matures.

What will happen to the client? He will be stuck with a low yielding bond. Others put up $1000 and get back $50 a year while he puts up the same amount and gets back $20 a year.

What if he sells? The market will demand 5% interest (coupon rate) for bonds. His $20 coupon will be the 5% interest. Therefore he can only sell his bond for $20 / 5% x 100% = $400. MUCH MUCH lower than what he bought it for. This equates to a $600 loss!!!

To those who are selling bond related products: Know what you are selling at this current point in time before making a recommendation.