How can a bond fund achieve 15 return
Pension funds: why it is not worth it now
Lana Iliev, April 30th, 2021
For a long time, pension funds were considered a particularly low-risk investment for old-age provision. But in the Phase of low interest rates they are becoming more and more unattractive. In this post you can read what pension funds are, why they currently do not seem to make sense and what alternatives there are to pension funds.
What are pension funds?
Pension funds (also: bond funds) are investment funds, the majority of which are in fixed income securities invest in the form of bonds (also: bonds, debentures, bonds or interest-bearing paper). Pension funds generate profits through both the regular interest payments (Coupon) as well as by trading the interest-bearing securities.
The prefix “pension” is in no way related to personal pension provision. The name is simply derived from the term 'annuity paper', a common term for bonds.
What are the reasons to invest in pension funds?
Those who invest their money in bond funds usually hope for continuous income through dividend payments. In addition, pension funds are considered to be particularly low-risk and are often recommended as an important part of a portfolio to offset any losses through stocks or equity funds and to create stability through risk diversification.
But why exactly is this recommendation so often made and why are pension funds considered low-risk securities?
First of all, funds generally offer 3 advantages for the investor:
- Time saving, as the securities are not selected and managed by themselves
- Expertise of the fund management in the selection of bonds
- Diversification into a large number of different bonds
In addition, the bond is considered less risky compared to the share. One of the reasons for this is that the Fluctuations in value of bonds are on average lower than those of stocks. In the case of corporate bonds, it is also the case that the holder of the debt security in the event of the insolvency of the issuerserved in front of the shareholders become.
But not every interest-bearing security has the same risk profile. It is primarily government bonds issued by countries with a high credit rating that are considered to be particularly low-risk. For this reason, not every pension fund is a safe bet. In addition, due to the currently prevailing low interest rate level, there is a special high risk of interest rate adjustments. You can find out more about this in the 'Risks' section.
How do you choose the right pension fund?
If you want to invest in a bond fund, you should find out more about it and first consider whether the investment is yours personal investment horizon and to yours individual strategy fits.
Additionally, you should be wondering if you are into one distributing or in one accumulating funds want to invest. Also about that Fund volume and the Reputation of the fund manager you should seek information. You can then compare the pension funds that are suitable for you from the following points of view:
How are the funds structured and in which bonds do they invest?
|Issuer: Does the fund have a focus on corporate or government bonds?||It should be noted here that corporate bonds and stocks belong to the same asset class. If you have already invested in stocks and would like to build a broad portfolio, then bond funds that invest in government bonds are probably suitable products. Real estate crowdinvesting can also be exciting, as you can earn high interest rates away from the capital markets.|
|Creditworthiness: What about the creditworthiness of the companies or countries that issue the bonds?||A good rating means less risk, but also less return. For this reason, there are bond funds that specialize exclusively in bonds with poor credit ratings. High yield bond funds contain bonds issued by companies with low solvency (also called junk bonds). Emerging markets bond funds on the other hand, they contain government bonds that are issued by emerging markets and that are just as often of poor creditworthiness.|
|Region and currency: Which region do the bonds come from and in which currency are they issued?||Global bond funds acquire bonds from many different countries and thus increase the potential for returns. At the same time, however, the foreign currency risk also increases here (more on this under 'Risks'). To avoid such an exchange rate risk, you can click Euro pension funds put.|
|Running time: What is the remaining maturity of the bonds the fund holds?||Money market funds rely on bonds with short maturities, for example. This manifests itself in a lower return, but also means more security.|
|Share portion: How high is the equity component of the pension fund?||Every now and then bond funds are also mixed funds and do not invest entirely in bonds, but also invest part of the capital in stocks. As an investor, you should find out which investment guidelines the fund follows and how the fund's investment structure is structured. You should check to what extent the weighting between bonds and stocks fits your personal goals.|
How is the return on the pension fund to be assessed?
There are three key indicators for assessing the return on bond funds:
1. Effective interest rate
The Effective interest rate or Yield to maturity describes the return on all bonds in the fund, provided that these would be held until the end of the term. However, since bond funds do not do this, but rather trade the interest-bearing paper, the effective interest rate is only used as a rough guide.
2. Current return
The ongoing return always refers to one year only and indicates the relationship between the coupon and the bond price of the fund's bonds. In the case of distributing annuity funds, the current return is also the payments that investors can expect annually in the form of dividends.
3. Modified duration
This key figure can be used to estimate what will happen if the market interest rate changes. The modified duration basically simulates what happens to the fund value if the general interest rate changes by 1%.
For example, if a bond fund has a modified duration of 5, this means that the fund's value will rise by 5% if the market interest rate falls by 1%. On the other hand, if the market interest rate rises by 1%, the value of the bond fund falls by five percentage points.
What costs should you watch out for?
Last but not least, you should get a thorough overview of the costs involved in investing in a pension fund. Bear in mind that the costs incurred reduce your return on investment.
In order to purchase shares in pension funds, you must have or open a bank deposit. Banks charge fees for opening and managing such a custody account. Alternatively, you can also use an online deposit from a direct bank. This is usually cheaper than with a conventional bank. Use one of the numerous securities account comparisons on the Internet, e.g. from Finanztip or Check24.
The pension funds themselves also charge fees for administration, transactions and, if necessary, bonuses for managers. To compare the costs of different funds, you can use the Total expansion ratio Consult (TER). This key figure summarizes the annual costs and shows them as a percentage.
In order to save fund costs, investors often switch to passively managed index funds, so-called ETFs. Bond ETFs are a cost-effective alternative to bond funds.
Where can shares in pension funds be bought?
Units in bond funds can be acquired through fund brokers, banks or online custodian banks and various stock exchanges. The offer differs from provider to provider.
What are the risks of pension funds?
Pension funds are generally considered to be a low-risk investment, as bonds, as fixed-income securities, have a reputation for being safe. Nevertheless, you should be aware of the risks, even if they are lower than with other investments such as stocks.
Foreign currency risk (also: currency risk or exchange rate risk)
As with bonds, bond funds also have an exchange rate risk. If the fund contains bonds that were issued in foreign currencies, fluctuations in the exchange rate of these currencies can have a negative impact on the return.
Bonds have different levels of risk. Information about this is provided by the creditworthiness of the issuer. If this is low, there is a particularly high probability of failure. For this reason, you should always find out what kind of bonds a pension fund is investing in.
Interest rate risk
The interest rate on bonds changes depending on the general interest rate level: If the market interest rate rises, issuers also issue bonds with higher interest rates. If interest rates fall, they issue bonds with lower interest rates.
This means the following for the price development of bonds and pension funds:
A falling market interest rate leads to an increase in profits for bond funds. Because the newly issued bonds earn less interest than those that have already been purchased. The bond fund can thus sell the bonds it has already acquired at a good price.
A rising market interest rate, on the other hand, causes the bonds already acquired to lose value. Because the newly issued bonds earn better interest. This makes it difficult for a bond fund to sell the bonds it has already acquired at a good price.
What is the current state of bond fund returns?
Due to the currently prevailing phase of low interest rates, bond funds were initially able to benefit from the falling interest rate level in recent years. Since newly issued bonds showed lower and lower interest rates, bond funds were able to sell the bonds they had already acquired to increase their value. This initially caused the fund's returns to rise.
In the meantime, bond prices are so high and interest rates are so low that bond funds are actually no longer generating any interesting returns. In some cases, securities with negative interest rates are currently being issued.
For example, the yield on 10-year federal bonds (government bonds of the Federal Republic of Germany) is currently around 0.5%. In July 2016, however, it fell to an all-time low of minus 0.2%.
In addition to the meager returns, however, there is a risk of a turnaround in interest rates and thus the particularly high risk of an interest rate change. Should the European Central Bank (ECB) decide to increase the key interest rate again, this would be particularly fatal for pension funds. The bonds they hold would then lose massively in value, because the newly issued bonds would earn better interest.
As long as the interest rate level does not normalize again, investing in pension funds can be advised against.
What alternatives are there to pension funds?
At the moment, pension funds are no longer the safest form of retirement provision, because with an investment threaten losses. As an alternative, fixed-term deposits are often recommended these days, because the prospects for returns are currently higher than with bond funds.
However, if you want to build up secure retirement provision, you should generally distribute your capital across several asset classes and create a certain diversification in your investment portfolio through sensible asset allocation.
Crowdinvesting is a good way to expand your portfolio, for example, with a small investment volume to include the asset class 'real estate'. As with bond funds, investors get here fixed interestthat for investment opportunities that are brokered by the crowdinvesting platform BERGFÜRST, for example between 5.0% and 7.0% per year lie. In this way, you not only expand your investment spectrum with a portfolio component and possibly a new asset class, you also receive an investment with an interest rate that is above the current market level.
Try real estate crowdinvesting now for free
Image Copyright: Jacob Lund / Shutterstock.com
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