Bonds basics – I’m bond, James “Bond”
I am now in the second post in the series of savings, mutual funds, bonds and CDs and the like, conservative investment instruments. Now I am going to discuss bonds. Here are the basics to bonds:
A bond is very basically a loan and you are the lender. Who's the borrower? Usually, it's either the US government, a state, or a big company like General Motors, if you are lending money to the US government. In Singapore, it is a little known fact that the Singapore government issues bonds too. Many government and business entities need a lot of money to operate - to fund the federal deficit or to build roads and finance factories, for example - so they borrow capital by issuing bonds. Bonds are actually very big business, especially in the United States.
When a bond is issued, the price you pay is known as its "face value." Once you buy the bond, the bond issuer promises to pay you back on a particular day - it's called the "maturity date" - at a predetermined rate of interest - the "coupon." Say, for instance, you buy a bond with a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect interest payments on the bond adding up to $50 in each of those 10 years. When the decade was up, you'd come back to get back your $1,000 and walk away.
A key difference between stocks and bonds is that stocks make no promises about dividends or returns. For instance, General Electric's dividend may be as regular as a heartbeat, but the company is under no obligation to pay it. And while GE stock spends most of its time moving upward, it has been known to spend months or sometimes even years going the other way.
On the other hand, when GE issues a bond, however, the company guarantees to pay back your principal (the face value of the bond) plus interest on the bond. If you buy the bond and hold it to maturity, you know exactly how much you're going to get back, basically. That's why bonds are also known as "fixed-income" investments, as they assure you a steady payout or yearly income. And although they can carry plenty of risk sometimes, as all investments do, this regular income is what makes bonds inherently less volatile than stocks.
As an aside: “Some say that gentlemen prefer blondes; that is incorrect, as it should be: Gentlemen prefer bonds J” (Old joke.)
Bonds basics
Savings, deposits, CD basics
Savings, deposits, CDs and all the basics you need to know for finance (apart from investment ideas and investment knowledge basics)
In my last few posts I did a series on making money online, but now I am back to information regarding more basic and simple topics, like can I make money from savings and CDs (certificates of deposits). As this blog is on ideas on how to become rich, and I am targeting a wide variety of readers, I shall now complete a series of articles for people who are risk averse and still wish to make money via deposits, mutual funds, index funds and the like. Investment may be something that you will want to look into also, and you can access investment basics and ideas here on my blog.
Topic for this post: Savings and deposits, (CDs) Banks’ Certificates of Deposit
Here, you lend a bank your money for a specific amount of time (up to, say, for instance five years). In return, you receive a set amount of annual interest and when the CD reaches maturity, meaning that it expires of ends, you come and get your money back. As a side note, this appears to be the most common plan for some Singaporeans to save money, as they lock it up in the bank where they cannot touch it and collect interest on it and don't have to think so much about making money.
How much interest you earn is the key to making money with CDs. And that depends on a number of factors such as which bank you visit and look around, the prevailing interest rate and how it compares to the inflation rate, how much money you invest and how long you lock it up for. It's important to note that inflation affects your interest rates because the higher the inflation the higher the rates, and hence you do not necessarily earn as much as with a lower inflation and lower interest rates. You can look around the banks and see what the rates are like as they change very often and usually depend on economic conditions or the like. In Singapore, generally the interest is usually very low, and in other countries, especially the United States and Britain generally the interest is usually better and higher.
When buying a CD, there are two terms you may need to know: the annual percentage yield APY and the annual percentage rate APR (Yahoo.com). The yield is the total amount of interest that you will earn in one year. It's expressed as a percentage of what you invest and takes into account that the way the bank compounds the interest. The rate is simply the interest rate you will earn for that year. If, say, you earned 1% per month, the APR would simply be 12%. But the APY would be 12.68%. That's because here the APY takes into account the compounding effect on the interest you earned earlier in the year.
For conservative investors, the best thing about CDs is that your money is safe, relatively speaking. When you purchase one through a bank, your total assets there should be insured, so there’s no worry there. The other advantage is that you know what's coming back to you, and hence you can plan accordingly. And you're still earning more here than if you let that money rot away in a savings account earning a paltry interest.
However, there are several big problems with CDs that everyone should be aware of: They have usually tiny returns as compared to other investment devices, they can lock up your money for the long haul and for many years, and they may not counter inflation. If you buy a five-year CD in 2002, for example, you can't get the money out any earlier than 2007 without paying a steep penalty. Even on a one-year CD, you might even be penalized for instance three months’ worth of interest. That's why a money market fund or an index fund may be usually better alternatives. The rates may sometimes be slightly lower, but you can always come back and withdraw your money whenever you see fit. Also, CDs may not be inflation proof, where sometimes your CD may not even be enough to counter inflation. The reason is that you are still taking in the older interest rate even when the general price level increases overall, thus shaving off your gains.
In other posts in this series we will be discussing about mutual funds and more on stocks and shares. Visit my website once again for more information!
