How Safe are Fixed Income Securities from a Stock Market Crash?

Fixed income securities are the hottest investment products in Singapore this year. But are they really as safe and risk-free as they seem?

Fixed income securities are being pushed all over Singapore this year. Whether you hear it from banks, financial advisors, or wealth managers, at least one finance professional will probably try to convince you to invest in these.

But what are fixed income securities, and why does everyone suddenly want to sell you some? Should you even buy them?

What is a Fixed Income Security?

A fixed income security is an investment that provides a fixed amount of payments, and a predictable return. A typical example would be a bond.

Say you buy a bond with a par value of S$10,000, which matures in 10 years. There is a coupon of 5%, which is paid out every year. You would thus get S$500 a year for 10 years. After the 10th year, you will receive the bond’s value of S$10,000.

This type of bond is thus a fixed source of income.

A fixed income security differs from variable income investments, such as stocks. When you purchase these kinds of assets, you are not guaranteed any fixed returns. For example, stocks sometimes pay out dividends, but they may not when times are bad. There is also no guarantee that you can sell the stock at a given price.

Fixed Income Securities Sound Great, Why Don’t We ONLY Buy Those?

Some people do indeed buy only fixed income securities. However, many financial advisors will point out this is a risky idea. This is because many fixed income securities, such as bonds, do not have high pay outs - they may be safe, but they may also fail to keep pace with inflation.

To better understand why, you may want to think in terms of lending money, and being part of a business.

When you buy a bond, you are effectively loaning money to the company or government that issued the bond. They are obliged to pay you interest (the coupon), as well as the amount owed, regardless of how well or poorly they are doing. It is a debt.

However, they are not obliged to pay you more if they are doing well either; in the same way your bank cannot ask you to pay back more for your loan just because you got a raise. You will get no more nor less than the amount promised.

When you buy assets like stocks in a company however, you are getting equity. You are not lending money to the company, but joining them as a part-owner in the business. You will lose money with them if the company does poorly; but if the company does well, you will also profit with them.

There is no theoretical limit on how much a stock can grow in value; companies like Facebook have made their shareholders millionaires overnight. The same, of course, cannot be said of people who merely loaned money to Facebook (they just got back exactly what they were owed.)

As such, most financial advisors will suggest a mix of the two: have some fixed income products to ride out economic downturns (they pay the same regardless of the economic situation), but have other products to benefit off market booms.

Why Are So Many People Trying to Push Fixed Income Securities in 2016?

This is happening because 2016 looks set to be a terrible year for financial markets.

In the first week of 2016, China’s stock market crashed and pulled the rest of the world down with it. Shortly after, Saudi Arabia’s execution of a prominent Shia cleric started a showdown with Iran. The conflict between these two major oil producers has unpredictable effects on the price of oil, which have already been unsustainably cheap since 2015. Low prices are not good, as they threaten many key business interests in Singapore (e.g. our big business building oil rigs) as well as the rest of the world.

We could go on with a whole other list of problems, but suffice it to say that 2016 looks to be a rough year. A serious economic downturn is looming. Hence all the push toward fixed income securities: financial advisors are often point to them as a safe haven in these situations.

However, there are some key things to remember before rushing out and buying them:

Look at specifics; not every fixed income security is safe
Fixed income securities tend to have lower returns
Some fixed income products can tie up your money for a long time

1. Look at Specifics; Not Every Fixed Income Security is Safe

An important consideration, before buying a bond, is the credit rating of the issuer. Companies can go bankrupt and be unable to pay the bond, which could lose you a lot of money.

Even governments default on bonds sometimes (and when they do, there is nothing you can do about it. What action can you take? Invade the country?)

If you are not familiar with bonds, stick to investment grade bonds (BBB- or higher.) In fact, most financial advisors will only introduce you to bonds rated AAA (the safest possible bonds.) You should be wary of anything more risky. Note that bond ratings measure safety; their grade is not a recommendation to buy.

Only consider bonds that are presented by a qualified wealth manager or financial advisor. Do not try and pick the bonds yourself; they can be more complex than they seem.

2. Fixed Income Securities Tend to Have Lower Returns

In exchange for their relative safety, fixed income products generally don’t grow your money faster than assets like stocks (although most still beat fixed deposits.)

As an example, a Singapore Savings Bond (SSB) is one of the safest products you can buy. However, even if left to mature for 10 years, the eventual returns will only come to around 2.5% per annum. As inflation is often around 3% per annum, it is not the best idea to rely just on SSBs.

As mentioned above, a balanced portfolio should have a mix of higher risk assets mixed in with fixed income products.

3. Some Fixed Income Products Tie Up Your Money for a Long Time

When you want to get your money out of a bond before it matures, you will have to sell it on a secondary market. This is a process that can be troublesome to the layperson (and often means fees.) Likewise, some bonds cannot be sold on a secondary market - you will just have to wait until they reach maturity.

This can result in your money being tied up for long periods. If there is a chance that you may need the money on short notice, you might want to consider an alternative product (e.g. exchange traded funds), which can be quickly sold.

Whatever the case, try to clear your debts before investing. It is unlikely that you can “out-invest” the interest rate of your loans, whatever the products you choose. Ensure your debts are under control before you even consider different types of investing. SingSaver.com.sg can give you access to cheap personal loans to consolidate your debt.