Investing 101: How Do Bonds Work?

In recent years, we’ve become more familiar with bonds and might have invested in them for the very first time ever, whether in the form of government bonds or bond funds. You might not even know that you have exposure to bonds, but if you own an insurance savings plan or a whole life policy, it is very likely that a significant part of the underlying assets is indeed made up of bond investments.

So what exactly are bonds and how do they work?

How does a bond work?

Bonds are basically the lending of money to entities like companies or governments. In turn, lenders get interest in the form of coupon payments at regular time intervals. This is also why traditional bonds are sometimes known as “fixed-income” instruments because they offer predictable interest payments.

For instance, when you buy a 5-year government bond for say S$10,000 with a coupon rate of 3%, you will be getting S$300 every year until the bond matures. Over 5 years, that’s S$1,500 of returns in all and when the bond matures, you get back your capital of S$10,000.

Are bonds safe?

Are they safe investments? It depends on a few factors.

Credit Rating

When you lend someone money, whether you’d get your money back obviously depends on whom you’re lending the cash to. Your best friend of 20 years needing some cash? It’s probably quite certain that you’d get your money back. Lending to your gambling ex-classmate friend whom you don’t know that well, however, becomes a lot iffier.

In the world of bonds, agencies like Standard & Poor’s and Moody’s give bonds credit ratings so that investors know what kind of risk they are taking. It’s a lot like our own credit reports when we apply for credit cards or take up loans. Generally, higher rated bonds are safer and hence the borrowers will offer lower coupon payments. With a high enough rating, these are considered “investment-grade” bonds.

On the other hand, lower rated bonds tend to offer higher coupon payments to compensate for their poorer creditworthiness. With low creditworthiness, such bonds are also called “junk bonds” or “high-yield bonds”.

Duration

The duration of the loan can also affect the risk. You could be very sure that your bestie would return you what they owe after a month or two, but what if they need it for 10 years? A decade is a long time and hence the risk of the loan increases.

This applies to bonds as well. Generally, shorter-term bonds are considered safer than longer-term bonds. The uncertainty of things naturally increases with time, so we can expect the risk of a bond to also go up with the length of the tenure.

So I can lose money on bonds?

Indeed, while bonds are considered “safer” investments, the risk of a bond investment can vary greatly depending on the creditworthiness of the issuer entity and the tenure of the bond. This is called default risk.

A well-known example of a bond default that happened recently is Evergrande Group’s bond default. Once one of China’s largest property developers, Evergrande borrowed aggressively to fuel its rapid expansion.

The company eventually missed several bond interest payments and officially defaulted in December 2021. Bondholders faced steep losses as a result.

Bonds can also fluctuate in value

Bonds can also fluctuate in value due to interest rate changes. If you intend to resell your bond before it matures, you are exposed to interest rate risk. Generally, bond prices moves inversely to prevailing interest rates — when rates rise, bond prices tend to go down, and vice versa.

For instance, if you lent Person A S$1,000 for a year and charge 3% interest, you will get your S$1,000 back with 3% interest if Person A is a reliable and upstanding person who pays back. You could even sell this loan to Person B if you urgently need the money before Person A can pay back.

Before you sell it, if interest rates drop sharply to a hypothetical 1%, your 3% bond now looks fantastic in value and you can sell it for a higher value to Person B. If rates rise sharply to say 5%, however, your bond is now less attractive and you might have to sell it at a loss to Person B.

If you don’t need the money now and can wait until Person A repays, by all means you can do so to continue holding your loan and collect your principal at the end of the loan tenure when Person A pays you back.

All things equal, bonds are safer than equities

Despite the risks, bonds are generally considered less risky than equities. When you buy a bond of Apple, for instance, you can count on getting your money back as well as predictable interest payments as long as the iPhone maker continues to have enough money to pay you back. A share of Apple, on the other hand, gives you the full upside as well as downside of the company’s business. A tariff here and a regulatory ban there can cause your stock value to plummet in a short period of time, making the stock a riskier investment than the company’s bond.

Let’s say the company does go out of business, liquidators will sell off the company’s assets like unsold inventory. The proceeds will be used to pay bondholders first before the remaining, if any, is paid to shareholders. This is yet another reason why bonds are generally safer than equities.

Of course, some bonds can also be riskier than stock and shares. If you lent money to a fledgling young startup promising to revolutionise smartphones, it might be a lot riskier than just buying shares of Apple.

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Seth Wee was a licensed financial adviser representative from 2009 to 2025, with over 16 years of experience in Singapore’s financial advisory industry.

He started Sethisfy.com in 2019 to share practical insights on credit cards, banking products, and miles strategies, helping readers identify financial products that deliver the best value. Seth has been featured in CNA, Channel 8, Today, and a host of other publications. In 2025, he was also part of a panel at CPF’s Ready For Life festival.

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