Brexit: What Should I Do with My Portfolio?

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Since the UK voted to leave the European Union on 23 June, global markets and currencies have reacted negatively to the uncertainty, with a significant falls across all major equity markets. The British pound fell to a three-decade low against the US dollar – its biggest one-day fall on record. Markets are likely to remain volatile until it becomes clear what Brexit will mean for the UK and the rest of the EU.

What does all this mean for your portfolio? Clearly, no one knows for sure. But no matter how markets react in the next few months, you should follow this advice: Don’t let fear of the unknown – or your emotions  make your investing decisions for you.

Why we let emotions drive our investments. We tend to be controlled by our emotions regardless of circumstances. We become overly excited and ready to invest at the worst possible times. And when it comes to deciding how to invest, we often rely on poor advice, a hunch or worse – speculation we heard on the news or the radio. On the other hand, we sometimes let our fears and emotions keep us out of the game altogether.

How to take the emotion out of your investment strategy. Whether you’re worried about how global events might affect your portfolio or just fearful in general, the best investment strategy is one built for the long term. In other words, once you map out a lifelong investing strategy with your financial advisor, you should have confidence in that strategy regardless of the blips you’ll endure along the way.

While it can be fun to “play” the markets, investors should refrain from playing or risking too much on a handful of bets. It is much more prudent to keep your investments boring by broadly diversifying across big and small companies, domestic and foreign companies, and between stocks and bonds.

If your portfolio is properly diversified, stay cool and await developments.

At the end of the day, investing is a game of consistency – one where the investors who take the longest approach usually win. And when it comes to emotional investing – whether out of fear or confidence – the only way to win is not to play.

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The Truth About Diversification

Most investment advisors including myself, believe that building and maintaining a diversified portfolio is the most prudent way to help clients invest their money.

Not only do numerous studies of asset class returns back this up, but no matter how smart and experienced the advisor is, it’s near impossible to predict with consistency which asset class (e.g. stocks, bonds and cash) will outperform in any given time frame.

Studies on long-term investing have shown that more than 90% of the variations in a portfolio’s return can be attributed to the asset allocation decision.

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That isn’t to say that it doesn’t take skill and expertise to build a diversified portfolio – it does – there are many metrics that come into play such as growth prospects, valuation metrics, and global economic trends.

The truth about diversification is that a truly diversified portfolio will not provide the return of the best performing asset class over a given time period, nor will it match the return of the worst performing asset class. The return will be somewhere in between. Which is exactly the point – the highs are less high but the lows are less low making it more likely that an investor will not panic and change strategy at exactly the wrong time. This applies to both professional and individual investors.

The truth about diversification is that it isn’t a strategy designed to predict which asset class will outperform each year, but rather to gain from the outperformance in some asset classes while avoiding the lows in others and in the end producing solid average returns. Liken it to the Tortoise and the Hare story…as the Tortoise said: “slow and steady wins the race.”

4 Simple Ways to Invest for The Long Term

Most people do not want investing to take up too much of their time and effort. This is due to us having many other things in life to focus on, such as our careers, families, housing etc. And so, trading, timing the market and stock picking is not suitable for 90% of retail investors.

So how can you grow your money without taking up too much time and effort? Here are 4 simple ways to do so and if you stick to this, there will be a high chance for you to retire comfortably after 20 to 30 years.

1) Start Early & Stay Invested

Inexperienced investors looking to grow their money without active monitoring can first look to compound interest to pursue gains over time. The key ingredients here are starting early, and staying invested. By doing so, you will have more time to grow your money. The table below shows how even saving and investing a small amount every month when you are young benefits you, simply because of the power of compound interest.

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2) Diversify Your Portfolio Among Various Assets and Geographical Regions

Market timing and stock picking are not suitable strategies when you want to invest passively. What you can do is to construct a well-diversified portfolio.

Diversification involves another important concept – Asset Allocation. This means mixing you portfolio among various asset classes to spread your risk. The most common asset classes for retail investors are: equities, bonds and cash. A lack of diversity means less liquidity in times of need.

A simple two-asset portfolio, comprising bonds and equities, helps to enhance returns and reduce risk. The proportion of a person’s investment portfolio to be allocated in bonds should be equal to the person’s age (or age minus 10 if he/she is more risk tolerant).

The reason behind this formula is because as we age, we are closer to retirement and should safeguard out nest egg by having less exposure to risky assets such as equities. For young people who mostly have higher risk tolerance, they can allocate more of their investments in equities which can potentially yield higher returns. I have written a separate article on why we should invest in equities if we have a long investment horizon to prepare for retirement.

Besides the classes of assets, having a basket of stocks spread across different geographical regions can reduce your long-term portfolio risk.

Interestingly, we should note that much research have shown that more than 90% of investment returns are determined by asset allocation. Only 10% is influenced by stock picking and market timing. The pie chart below illustrates the recommended asset allocation for a person with a moderately aggressive risk profile.

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3) Invest Regularly – Effect of Dollar Cost Averaging

Every stock investor may fall into the trap of emotional or irrational investing. This stems from our 2 strongest emotional forces – fear and greed, which leads to failure to grow our money.

1. Fear – When the price of our stock holdings fall, a common response stemming from fear is to sell our shares and cut our losses. Subsequently, when the stock price rises, we may be afraid to invest in the stock again. If the stock price continues to rise, we may enter the market too late to see any substantial return.

2. Greed – When we see the price of a stock going up, greed drives us to invest our money in it, with irrational optimism that the price will continue to rise. Quite often, the stock price drops instead.

Emotional/irrational investing often yields little returns for retail investors. Instead of speculating on a stock price, we should do quite the exact opposite – We should set aside a fixed amount of money to invest regularly, regardless of how the stock market is performing. The graph below illustrates what happens if we invest a fixed sum of money on a monthly basis for a certain stock, X:

DCA graph

This enables us to take advantage of Dollar Cost Averaging, a passive mechanism which helps you to buy less of an investment when the price rises, and more when the price falls. This lowers your overall purchase price for investments in the long term.

4) Review and Rebalance Your Portfolio

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Given the dynamic global economy, investors should review their investment portfolio regularly and change the mix of assets, a process called rebalancing. Rebalancing safeguards your portfolio from being exposed to undesirable risks and maintains your original desired asset allocation. This would ensure you are on track to meeting your financial goals.

Manage Your Wealth Like a Football Team

Just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards.

In a game of football, let’s imagine if we have a team with a great goalkeeper and defenders but without strong forwards, will we be able to win? Well, the best possible result may perhaps be just a draw. In reality, when it comes to managing wealth, many people have made the mistake of being too conservative.

footballA dangerous thought which they have is keeping all of their savings in their bank accounts, assuming it is the most reliable way to make their money grow. However, they have forgotten the fact that bank interest rates can never keep up with the pace of inflation. Over a long period, the savings of these people will diminish in terms of purchasing power.

On another hand, can a football team do without a dependable goalkeeper and defence? The answer is certainly no. When facing the fierce attacks of an opponent, a team with a weak defence will be in shambles and suffer terribly. Similarly, without proper insurance cover to protect our wealth, if any disaster strikes, a rich man can very quickly become a poor man. Therefore, just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards. With this analogy, let’s look at these 3 departments in wealth management.

1. Defence: Emergency Fund & Insurance

As the saying “Saving for a rainy day” goes, we should aim to keep an emergency fund of 3 to 6 times of our monthly expenses. This sum of cash will come in handy when events like a salary cut or retrenchment happens. For this emergency fund, we can save our money in bank savings accounts, fixed deposits or money market funds.

At the same time, we should also purchase insurance. For instance, hospitalisation insurance covers your medical bills in case of an accident or critical illness. Surgical fees can amount to over tens of thousands of dollars, and treatment for long-term illnesses such as kidney dialysis can cost more than $20,000 annually. With adequate protection, it gives you a peace of mind that unforeseen circumstances are prepared for. To understand your insurance needs, you can refer to an earlier post here.

2. Midfield: Endowment and Moderate Risk Investments for the Mid-Term

A strong midfielder has to be able to support the forwards and help out in defence. You can think of putting your money in investment instruments with moderate risks, such as savings endowment policies and balanced funds which invests in a mix of fixed-income (bonds) and equity, some with a larger portion in bonds. Alternatively, you can set aside a pre-determined amount to invest every month in global funds. This strategy of dollar cost averaging can help your money grow in the mid-term.

3. Forwards: High Yield Investments

With a solid defence and reliable midfield, if you have a surplus of cash and wish to grow it, you can put your money in investments with high returns and high risks. Such investments include real estate, stocks, currencies or sector funds. For those of you who actively keeps an eye on the stock market, you should have a super-sub forward – an opportunity fund. Every crisis comes with an opportunity. Whenever there is a global stock market recession, we are presented with an opportunity to buy stocks at very low prices, like it were the Great Singapore Sale. If you had bought DBS shares in early 2009 when the price was $7 per share, you can sell them off at $16 per share now and earn a huge profit.

Here’s to your financial success by managing your money just like a football team, or for the matter, any other team sports which requires a defence, midfield and forwards.

3 Mistakes in Retirement Planning

retirementIt is common for young working adults to delay saving for retirement as they feel that they still have a long time before this stage in life.

Suppose you are 25 years old now and intend to retire at age 65. Given the average life expectancy of Singaporeans of 85 years old, you would have about 40 years to accumulate wealth and live the remaining 20 years without a working income.

Among the younger Singaporean parents now, most are only having 1 or 2 children. Due to the fact that the standard of living will increase in future, it is getting harder for our children to survive and take care of us when we turn old. It is not sensible to depend on our government too. Hence, the best way is to prepare now on our own, so that we can enjoy our old age without worries. Here are 3 mistakes you should avoid when planning for your retirement:

1. Saving too little

saving too little

Many people save around $100-200 per month. This is not sufficient if we want to retire at 65, and live a decent lifestyle (eg. travel once a year and eat out once a week). If you save $200/month at 6% growth per year, you would only have $400,000 in 40 years’ time. Naturally, if you intend to retire earlier at say 55, you have less number of years to save and need to thus save more.

2. Starting too late

When we are in our 20s, we save for marriage and our first house. In our 30s, we save for our children’s education. It is only when our children are much older, we begin to start saving for retirement. By this time, we are likely to be in 50s. Even if we begin at 40s, to meet our financial goal, we may need to turn to investments with higher yield. By not managing these higher risk investments properly, we may even lose our savings.

3. Playing it too safe or too risky

If we keep our money in the bank, the low interests paid are grossly insufficient to help us beat inflation. Hence, the purchasing power of your money is actually shrinking. On the other hand, if you do not know how to invest and just plunge into the stock market, you are likely to lose a lot of money. Depending on their risk appetite, there are different forms of investments which are suitable for each individual. The 3 most common forms in Singapore are shown in the following table:

Holding period Investment (low to high risk) Expected returns Risk of Loss
1 year Fixed deposit 1% Very low
5-10 years Bonds 3-5% Very low
17-25 years Stocks 7-15% Very low

For these 3 types of investments, the risk of loss can be minimised with their respective holding period. The riskier the investment, the longer the holding period required, and naturally you can expect higher returns. For younger people, there is an advantage with stocks because they have a longer time horizon to invest before retirement. Hence, it is also important for you to know which stage of life you are at, understand your purpose of saving & investing and select a product which fits your risk appetite.

At age 25, retirement may seem to be something so much later in future. But the later you start saving for it, the greater the amount you need to save. As an article from Lifehack suggests, one of the top 10 regrets (Point 8 in article) in life among people who are about to die is not saving more for retirement. Remember the saying, “You are the young person that can take care of yourself at old age”.