Lately, investors have started talking a lot more about fixed income products like bonds, cash management accounts and government securities. This is a far cry from the days of 2020 and 2021, when many investors were drawn toward cryptocurrency, NFT projects, growth stocks and other speculative investments that can give high, double-digit growth every year.
Replacing them today are investments like the Singapore government securities, money market funds or just topping up your CPF savings.
What happened?
Simple. Interest rate rose.
What happens to our investments when the interest rate increases?
When the interest rate increases, borrowing costs for companies go up. Companies now pay a higher interest cost on their loans, and this increases their overall expenses and reduces their bottom line. This is like how we pay more for our monthly home mortgage when rates go up.
The other reason is how interest rate affects the discounted cash flow model.
Simply put, money in the future is worth less than money today. And the higher the interest rate is, the higher the discount on future cash flow would be.
To explain, let me give you an extreme scenario.
Imagine if interest rates today is 50% per annum. This means if you give me $100 today, you will expect me to return you $150 next year. And if the interest rates go up to 100% per annum, then the expectation for the returns goes up from $150 to $200.
Let’s apply that logic now to a company’s valuation.
We invest in a company for its future cash flow. In other words, we invest today so that we can receive more income tomorrow. And as our earlier hypothetical example has shown, the higher the interest rate is, the greater the expectations we would have for future earnings.
So, with all things being equal, assuming future cash flow projection remains the same, a higher interest rate would mean that valuation today would have to decline.
What about bonds?
Traditionally, the idea is that when interest rate increases, bond valuation decline. If you learn finance in school, you already know why. I won’t go into the technical details. If you are not sure, read this article from Pimco that explains it well.
However, this only applies to existing bonds. As interest rate continues rising, the money from bonds that mature can be reinvested into newer bonds that will now be paying higher yields. Clearly, this makes investing in bonds when interest rates are high more attractive, relative to stocks.
However, this only applies to shorter-duration bonds or shorter-duration bond funds. If you invest in a single, 30-year corporate bond that pays 3% per annum, and the market interest rate goes up to 5%, you won’t enjoy the increase in market interest rate. This is unless you choose to sell your bonds in the secondary market and will likely have to accept a lower price for your existing bonds given that the interest rate is less attractive compared to the current market interest rate.
Cash Management accounts are one way we can take advantage of rising interest rates, especially if we are still unsure if rates will continue increasing. One such cash management account we can consider is MoneyOwl’s WiseSaver.
At the point of writing, the current rate for the WiseSaver account is 2.29%.
MoneyOwl is also offering a free $20 worth of WiseSaver Units. Do note this is limited to the first 500 qualifying clients who have created a WiseSaver portfolio (cash) from 1 August to 31 October 2022. Find out more details here.
For those who wish to invest in stocks and ETFs directly on their own, Syfe Trade gives us free trades each month and we can also invest in fractional shares. There is also S$80 in cash credit that we can enjoy if we start investing today via Syfe Trade. You can read more about this promotion and how Syfe Trade works here.
And if you want to learn how to invest and trade better, we also spoke to Kelvin Tan from the very popular finance YouTube channel Kelvin Learns Investing. Speaking to him, it’s remarkable how passion and interest can help one learn so much about finance in a short space of time – Kelvin was formerly a game developer.
The post Editor’s Take: Is It Time To Start Investing In Fixed Income? appeared first on DollarsAndSense.sg.
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