Bonds Aren't Boring...5% to 8% Annualised Returns, Here We Go!

A recent conversation with a fellow colleague in the staff pantry inspired this article. "Hey bro, I'm telling you bond index funds are the worst instrument to hold. I am down more than 10% even though I'm on a monthly regular savings plan (RSP) to purchase a local bond index fund with one of our local banks!" he lamented. Nodding on, I replied, "Hmmm, don't worry, when interest rates eventually start to come down, the price of your index fund will rise back up. But for now, you would do well sticking it out if the fundamentals of your bond index fund is doing all right." He look back at me blankly and asked "What do you mean? Bond index funds have fundamentals too?" Sighing, I gave him a pat on his back, "Yes bro, let me take you through this and also how one can achieve a reliable annualised returns from a seemingly low risk instrument like a bond index fund."

So yes, the title of my latest article isn't clickbait. Neither is it meant to put any individuals off. But the truth of the matter is that we probably need a mindset shift regarding how fixed income = low risk low returns. So here we go into this article which revolves around bond index funds or bond exchange traded funds (ETFs). (On a side note, feel free to refer to my previous article titled "Investing Made Simple: These 3 Funds Could Be All You Need As An SG Investor" on the reason behind why I select the Nikko AM SGD Investment Grade Corporate Bond ETF to form the fixed income portion of my lazy portfolio). Before anyone asks, no I'm not sponsored by Nikko Investments and neither do I receive any form of benefits from investing this often unknown local index fund ya.

1. The average credit rating of your bond index fund is extremely important. 

Remember when I mentioned about fundamentals of a bond index fund in my conversation with my colleague. Yes, the credit rating of any bond index fund is extremely important, in fact, I would even go as far to say that it is THE MOST IMPORTANT criteria when selecting any bond index fund. Let me tell you why.

Lets not go into the intricacies of it, but to put it in layman term. Would you buy a high yielding corporate bond index fund comprising of companies which have dubious cashflow, business models and whose operations are all concentrated in a politically unstable country? Such junk bond index funds would usually have a credit rating of C and below. In return they promise investors higher yields of more than 10% sometimes. Well I don't know about you, but I'll steer clear of such high yielding bond index funds.

So yes, the average A credit rating of Nikko AM SGD Investment Grade Corporate Bond ETF (SGX: MBH), which includes the likes of DBS, UOB and Changi Airport Group, would certainly give me a better night's worth of sleep. While MBH might not be as safe as a government bond ETF like its ABF Singapore Bond Index Fund counterpart, its dividend pay-out of above 3% (at the time of writing in June 2024) more than compensate of the additional risk. 

2. In order to get a higher return on your bond index fund, try to avoid currency risk.

Ok, I know this point is debatable, as USA treasury index funds have delivered 10% returns in the past. But hear me out ya? The point of fixed income, is to...as the name suggests, give you a regular stream of fixed income when we're all old gummies and no longer in the workforce. 

Hence, it is usually advisable to purchase a bond index fund in your local currency. This would firstly, save you the hassle to exchange the dividends which you receive into your home currency. Secondly, the annualised returns for bonds in generally pale in comparison to equities. Hence, you wouldn't want currency risk to erode your already not that high return. That's the reason why I chose the Nikko AM SGD Investment Grade Corporate Bond ETF.

3. Have the courage to buy when others are fearful.

This quote by Warren Buffett holds true not only for equities but also for bonds as well! We're in a unique investment environment where bond prices are still relatively depressed. Hence, the potential continued rally of bond prices when interest rates finally get cut by the FED could add onto your long-term returns. Just bear in mind that the returns from bond index funds come from (i) the dividends you receive and (ii) the potential capital gain when the price of your index fund go up. In this sense, I decided to allocate a larger portion of my dry powder into the Nikko AM SGD Investment Grade Corporate Bond ETF versus the Singapore Savings Bonds (SSB). On this note, don't get me wrong, SSBs are a fantastic tool for one to get started on purchasing your own investment securities and I too, store my emergency funds into SSB, but lets not derail.

Personally my average price for the Nikko AM SGD Investment Grade Corporate Bond ETF stands at $0.949. As of last week's closing price of $0.972. I have already gained about a 2.3% capital gain. Couple this with the annualised dividend yield of slightly more than 3% and till date, my annualised returns would be more than 5% (considering that I started purchasing this bond ETF from last year May). I don't know about you, but I'm feeling pretty good about a slightly more than 5% annualised returns from a local bond ETF that has a credit rating of A. With the potential bond price rally, that would come when the FED finally cut the interest rate, I would say that this "bond ETF still have legs to rally."

Turning to my colleague, I smiled and told him "And thats how you make 5% to 8% annualised returns from a relatively safe bond index fund bro!" Sighing, he replied "All right, I might just take a leaflet from this conversation. Thanks bro."

Yours sincerely,

Finance Kaya Toast

Disclosure: This article was written as me talking to myself as an ordinary Singaporean, wishing to achieve financial freedom. It does not represent any financial advise. All opinions are independent and represent just my two-cents on all matters financially-related.