Is it time to invest in bonds for passive income again?

Investing in bonds like the Singapore Savings Bonds (SSB) has historically been a preferred option amongst investors who want to diversify their investment portfolios and make passive income.

However, in the past few years, such fixed-income products witnessed a decline in popularity due to lowered interest rates intended to combat the economic challenges posed by the Covid-19 pandemic. At the same time, inflation concerns eroded the advantages of such investments because they no longer offered returns that kept pace with the increasing cost of living.

During times of economic uncertainty, investors wondering how to make passive income in Singapore were also leaning in favour of higher-risk asset classes like stocks and cryptocurrencies in the hope of growing their funds at a faster pace as opposed to investing in bonds that generally yield lower returns.

As the pandemic becomes a thing of the past, inflation showing signs of easing off and interest rates increasing with several Fed rate hikes, the bond market seems to have bounced back with higher yields.

Is it time to invest in bonds? Here are both pros and cons to help you decide.

Pros and cons of investing in bonds

Interest rates are at all-time high

The United States (US) Fed interest rate has been rising since 2022 from near zero per cent to 5.25 per cent in July 2023. This means that if you invest in bonds for portfolio diversification at the time of writing, the returns can be fairly decent compared to the pandemic period.

This is because bonds are particularly sensitive to interest rate changes. When the Fed increases rates, the market prices of existing bonds immediately decline and the yields on new fixed-rate bonds increase.

According to the US Department of the Treasury, the yield on the bond market's benchmark 10-year US Treasury note has even reached its highest level since 2007.

Protected from price fluctuations

High-quality bonds like Singapore Savings Bonds (SSB) are more likely to offer solid returns amidst economic uncertainties and at times outperform stocks. Unlike these bonds, stocks are heavily impacted by market pressure, corporate earnings and can experience dramatic fluctuation even within short periods of time.

Let's take the Bloomberg US Corporate High-Yield Bond Index as an example. The Index offers an attractive average yield of about 8.5 per cent and based on historical data as far back as 1990, the Index sustained an average yield of between 8 and 10 per cent for a total of 96 months and only 13 times of negative returns over the subsequent 12 months during the 2008 financial crisis.

However, it is good to note that successful bond investment lies in choosing high-quality and investment-grade bonds. If you are a Singapore investor wondering how to make passive income, investing in bonds may be a sound option, but only if you choose those that are able to ride out the ups and downs until they reach their maturity.

High yields, but risks remain

While there are bonds that present high yields that are rarely seen over the last 10 years, you must still exercise caution when selecting a fixed-income product. As with any investment products, there remains a chance for risk to arise when investing in bonds.

For example, bond issuers may default or periods of negative returns akin to the Bloomberg US Corporate High-Yield Bond Index's 12-month low can also occur to any bond.

Before you jump into the bond investment, be sure to focus only on high quality bonds with high liquidity. Investing in high-yield bonds may offer nice returns but these products are rated sub-investment-grade credit (BB+ or below) by Standard and Poor's (S&P) and Ba1 (or below) by Moody's. They are more likely to default and expose you to higher risk.

How to invest in bonds

If the current bond market is getting you excited to explore more, here are a few quick tips that can help you get started.

Understand the bond's rating

The rating offers a glimpse into the creditworthiness of the product. High-yield bonds are often given BB+ or below ratings while high-quality bonds like Singapore Savings Bonds (SSB) are rated AAA by Moody's, S&P and Fitch.

Any bond rated C or below is considered a low quality or junk bond and has the highest risk of default. When you understand the ratings, you can easily assess which bonds are worth your investment and resonate with your risk tolerance.

Consider macroeconomic risks

Rising inflation and interest rates pose risks for bonds. Interest rate risks may arise if rates change before the bonds reach their maturity date. However, it may not be easy to time the market or predict how interest rates may fluctuate with time. What may work to your favour in the long run is selecting high-quality bonds that match your portfolio diversification strategy and support your broader investment objectives.

Read the prospectus carefully

A prospectus is an important legal document that provides you with the full detail of the bond you are buying. This is where you will gather information about a company's investment philosophy and risks associated with the investment you are about to make.

In addition, check out the prospectus to clearly understand the bond's maturity date and penalty clauses that may affect your investment value should you decide to withdraw the sum before expiry. Related:

Bonds you may want to consider investing in

Singapore Savings Bonds (SSB) - SBOCT23 GX23100T

The Singapore Government's credit rating by Moody's, S&P, Fitch and R&I are Aaa, AAA, AAA and AAA respectively, and that simply means SBOCT23 GX23100T is a high-quality bond that is low risk and offers stable returns.

For those wondering how to make passive income in Singapore without having to go through much hassle, this 10-year bond is easy to invest in.

All you need is a local bank account (DBS/POSB, OCBC, UOB) and a Central Depository (CDP) account that is linked to the local bank account. You can also invest using cash or the Supplementary Retirement Scheme (SRS).

SPDR Portfolio Short-Term Corporate Bond ETF (SPSB)

This bond tracks the performance of the Bloomberg US 1-3 Year Corporate Bond Index. The fund offers exposure to US corporate bonds with maturities between one and three years.

The index includes investment grade, fixed rate, taxable, US dollar denominated debt with US$300 million of par outstanding, and is market cap-weighted and reconstituted on the last business day of the month.

10-year Treasury Note

The 10-year T-note is the most widely tracked government debt instrument in finance. Its yield is often used as a benchmark for other interest rates, like those on mortgages and corporate debt.

This bond is considered one of the safest in the world. The treasury yields are closely tied to the federal funds rate, so they should continue to move higher if the Federal Reserve keeps raising rates.

Vanguard Intermediate-Term Treasury ETF

Vanguard Intermediate-Term Treasury ETF seeks to track the performance of a market-weighted Treasury index with an intermediate-term dollar-weighted average maturity.

With more than 100 Treasury bonds within the funds, this is a high-quality bond which is low risk and offers an opportunity for capital appreciation.

iShares TIPS Bond ETF

The iShares TIPS Bond ETF protects you from inflation. The fund tracks the investment results of an index composed of inflation-protected US Treasury bonds and invests in a range of Treasury securities that have at least one year left until maturity, are investment-grade and have more than $300 million in outstanding face value.

Conclusion

If you are serious about investing in bonds for portfolio diversification and making passive money, check out our roundup of the best online brokerages.

Our research analyst has compared the top trading platforms based on a range of factors such as commission fees, international market access and exchange rates to ensure you will find a broker that resonates with your trading philosophy.

ALSO READ: What are T-bills ETFs and should you buy them?

This article was first published in ValueChampion.