Singapore Learning Investor

Avoiding Seductions in the Market: When Something Sounds Too Good To Be True

by Unknown - 02:59

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Removing Limiters: My Observations

by Unknown - 23:40

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Index Revolution: Why Investors Should Join it Now

by Unknown - 06:41

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My Strategy To Invest: Adopting the Couch Potato Portfolio

by Unknown - 11:40

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The Other Half Of The Pie: Bonds and Bond ETFs

by Unknown - 09:39

My name is Bond... what were you expecting?

When it comes to bonds, it's a fairly boring affair. However, it is very easy to understand and is a safe investment as you age. Let's crack it down and see how bonds and index funds can make a great portfolio.

I can tell you right now, in a long term investment, bonds will rarely (or probably never) make as much money as stocks or index funds. However they are much less volatile and if this is included in your portfolio, you can almost be sure that it won't hit rock bottom.

To put it simply, a bond is just money you loan to the government or a corporation. They will promise a certain amount of returns that is typically around 2%-4% annually, there are others out there that offer more, but most bonds come around this range. If this entity is able to repay your capital and interests, it's generally safe.

Bonds can be short, intermediate or long term. When you buy them, you can choose which you prefer. A short term bond can be as short as 1 year, while long term bonds can go up to 15-20 years. This means your capital is locked in for that amount of years and you will get back the same capital (if you deposited 10K, you get 10K, since interests are paid to your bank account every 6 months or 1 year) once the bond term ends, unless you sell it to a primary dealer before that (explained later).

However, different types of bonds presents different amounts of risks. In Singapore, the safest bonds are Singapore Savings Bond (SSB) and Singapore Government Securities (SGS), as they are from the government. So unless our government goes bust, you can almost guarantee your money is safe.

A good rule of thumb to see if the bonds fit your risk appetite is to know that the higher interest offered, the riskier the bond.

For Singaporeans, other than SSB and SGS, there is another common option, which is the ABF Bond Singapore Index Fund. It's an ETF of AAA-rated government bonds. Right now you're probably confused as to how bonds can be traded as ETFs, I'll get to that shortly. Let me elaborate about SSB and SGS first.

SGS: A Very Clear Explanation

SSB and SGS are very similar except in terms of liquidity and structure. They are both bonds backed by the Singapore government and is risk free as long as the government does not go bankrupt. Your capital is guaranteed for SSB and it depends for SGS. Here's why.

SGS is a traditional bond by the Singapore government. For this bond, the value of your bond increases when interest rates are low and vice versa. Let me explain why.

Assuming you bought a bond at $1000 SGD at 3% interest returns annually, that means that you're getting $30 annually. However, the next month/year when new bonds are out at an increased interest rate, say 5%, the value of your bond is now not worth as much as you paid for. Investors would rather get $50 annually than $30, so they would rather get the new bond that's just released. If they can get a 5% interest rate at $1000 SGD, why would they buy yours for the same? Of course alternatively if your bond's interest is higher than the new bond released, investors would be willing to pay more for your bond as the value is technically worth more than $1000 SGD.

In any case, note that the value of bonds only affects you if you do not plan to keep your purchased bond until maturity, be it 2,5,10 or 20 years. If you're not letting them go, the value of a bond doesn't affect you as you will just get your capital back. This applies to all types of sellable bonds, not just SGS.

I know what you're thinking. You bought bonds from the government, so who do you sell the bonds to if you wish to make a quick profit/loss (if your bonds rise in value due to lower interest rate, or if you just want to cut short your loss, which isn't a very smart move)?

Primary dealers are people who buys government securities from either a willing seller or the government directly with the intention of reselling bonds for a profit when interest rates are higher. That's who you're selling to if you intend to sell it. This is the only reason why your bonds can rise or fall in value. However, if you keep the said bonds you've purchased from the government till maturity, your capital is guaranteed, at no profit or loss, with the annual interests paid to you.

So to sum it up, bonds like SGS are loans that you give to the government or a corporation and they promise you an interest rate normally paid semi-annually or annually. If you keep it till maturity, you earn the interest rate annually until the end of the bond and when it matures, you get back your original capital. If you decide to buy or sell it, that's when the value of a bond matters, and you have to see if it's for a profit or loss.

SSB

The Singapore Savings Bond (SSB) is a newer bond released by the local government.

Firstly, it does not have a locked period. If you intend to sell it back to the government, the government will return your capital to you in 30 days. That means your bonds have much more liquidity compared to SGS. By the way, you cannot sell SSBs to Primary Dealers, it is only sellable to the government.

Secondly, the interest rates are increased over time. I.e to say, at the first year, the interest may be 1%, the second may be 1.5% and it increases every year. However, it follows the SGS market rates, therefore if you were to put the money in for 10 years in an SGS or an SSB, the overall interest gained is the same.

For a SGS, you get a fixed interest every year, and for SSB the interest increases over time. You will get lesser interest back at the start for SSBs, but at the advantage of liquidity if you need the money. If not, keep it till maturity and you will enjoy the same rate as the SGS.

The minimum amount to invest is SGS is also slightly more affordable, at a minimum of $500 SGD compared to $1000. However, there's a total limit of 100K for SSBs, and you can no longer invest if you have maxed the amount.

SGS or SSB? Why not both?

This is a common strategy. If interest rates are high, get SSBs to enjoy the higher interest coupons. Do not make the mistake of getting SGS as it will not benefit from a high interest rate (unless you want to keep it until maturity, then get it by all means). When interest rates gets lower, that's when you should get SGSs as you will be able to resell them for a higher value when you've waited till interest rates are high again. Some people I know do adopt this strategy, but I'm not very supportive of it.

In my personal opinion, I'm a fan of maintaining my bonds in SSBs due to the liquidity and to fulfil my main objective, to maintain a balanced portfolio the 'lazy' way. By having to buy and resell my SGSs and SSBs at different times according to interest rates, it's a hassle that I may not strongly favour. SSBs are designed to buy and hold, and if you wish to take advantage of higher interests, apply periodically instead of one lump sum of 100K.

The Third Alternative: Bond Index/ETF

That's right, bonds can be bought as index funds and ETFs. Since you probably know what an index fund is if you read my previous post, it's easy to explain. A bond index is simply the same as an index fund, except that instead of the top companies, it's a basket of high quality bonds (or whatever bond that advisor deems fit). When one bond expires or matures, another bond will simply take it's place. This can be bought as an ETF, which makes your portfolio way easier than having to switch between SSBs and SGSs. Just take it that you are now loaning money to a buttload of corporations and government entities instead of just the government or a single corporation, the theory is the same.

A great bond index in Singapore is the ABF Singapore Bond Index Fund, also by Nikko AM. They track the iBoxx ABF which comprises of high quality government bonds and government entities. They have generated annualised returns of 2.65% since inception (with compound interest in effect, that's a good lot of money if you've been investing since 2005), and has proven to have a steady track record thus far. I'm currently invested in this via POSB Invest Saver.

Since bonds are promised interest rates, you will discover that their returns will be generally lesser than index funds / ETFs (2.65% compared to 11.48%) which fluctuates based on market performance. Therefore, it is advisable to invest a lesser proportion of your money into bonds unless you are very conservative.

Why Should I Invest In Bonds Then?

Since index funds perform so much better than bonds, why shouldn't I invest all of my portfolio in it?!

That sounds logical at first, but...

Firstly, what is your original goal? To be mega-rich, or to retire early and live a comfortable life? The main purpose of passive income and dollar cost averaging is to generate returns for you to have a comfortable retirement without worries. If you need to liquidate your ETFs when you get old and the stock market is at an all time down, how much of your returns would you have lost?

With bonds, at times of emergencies you are able to liquidate without touching your index funds, and you can wait for a suitable time before selling the units at a much better price. When you reach an old age, your portfolio should primarily consist of bonds in order to be able to withdraw the dividends without touching the units inside, that is our ultimate goal.

That's right, never lose sight of your final goal. We want to generate a save passive income that allows us to not have to touch our units and let the money work for us. At the time of retirement, you cannot afford to wait ten years for the market to recover after a drastic market crash like you are able to now.

At the age of 23, I am able to handle 3-4 decades of market crashes (I would cheer for crashes as I can get units dirt cheap). However when I'm 60 and in need of a stable passive income, one market crash can ruin my entire annual income if I don't have a primary allocation of bonds in my portfolio.

In my next post, I will share about the portfolio strategy that is safe and effective. As an introduction, just know that young = index funds and old = bonds. It's the risk that you can take and the risk you cannot afford to take.

Till then, remember not to be greedy and aim for pure index funds unless you think you're lucky enough!

-WC

P/S: After I've gotten around how I'm planning my portfolio in the next post, I'm going to write a series of posts that educated me about numbers, good and bad investments, and also some terminology that you should know! So after the 'boring' stuff, let's learn little by little to make yourself more financially savvy! Don't just know what to invest, know how to invest!

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When Being A Couch Potato Pays Off: ETFs vs Index Funds

by Unknown - 07:14

"An out of town visitor was shown the wonders of the New York financial district.

When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor.

He said, 'Look, those are the bankers' and then brokers' yachts.'

'Where are the Customers' Yachts?' asked the naive visitor."

-Fred Schwed

What's The Difference?

For greenhorn investors like me, when deciding to invest in ETFs, the first question that comes to my mind is, "What's the difference between ETFs and Index Funds?

While I'm at it, I'll talk about actively managed mutual funds as well.

It takes a good amount of effort in reading up and looking up what is available in the market in order to know the difference, and what you should invest in. I'll simplify what I've learnt in this post.

Why Index Funds?

If you think that Exchange-Traded Funds (ETF) and Index Funds are the same, you're not that far off. In fact, they're so similar that it's hard to distinguish the difference.

An index fund is generally a mutual fund (one of many types) that is designed to track a specific market index (the most common in Singapore is the STI). This market index typically represents an entire stock market, and as you can tell, means that it consists of a number of stocks. The STI comprises of shares from the top 30 companies in the Singapore Exchange. A better known foreign market index is the S&P 500 Index, and as the name suggests is the top 500 large-cap US stocks.

If you're smart as a cookie, you would notice that it means your units will never go to 0 unless all 30 (STI) or 500 (S&P) companies goes bust. If not, your money is in a safe place 99% of the time. If one company folds or underperforms, another will take over.

An index fund tracks such a market index, which means lesser management is needed, thus the expense ratio and fees payable is much lesser compared to actively managed funds. It's a form of passive investing, which is my (our) exact goal in mind as it requires little attention and just some rebalancing at the end of every year.

Some of us may have met with financial advisors that sells you investment policies that invests heavily in mutual funds/unit trusts (both are similar except for legal structure), and the thing that entices you the most is their performance graph, or past year returns of 10% or more. This is the point where most people take the bait.

Firstly, they fail to take into account the hefty fees charged by the advisor and belittle the percentage charged (I've shown how 1% can cost you a whole deal in this post).

Secondly, they fail to recognise that past or recent returns are not indicative of the future. If you think that mutual funds when actively managed can beat index funds, let me lead you to the light at the end of the tunnel. The New York Times back in the 1990s held a competition for 5 well-known financial advisors to pit against the S&P Index Fund to see if they could beat the returns. They were allowed to switch funds at no cost and assumed a tax free account, so it's very fair. It was supposed to last for 20 years, but it stopped at the seventh year. Why?

The results? To your surprise (but not to real financial experts), the S&P Index crushed the competition. The 5 advisors started with $50,000 each and averaged about $138,000, with the lowest at $111,815 and the highest at $155,095. The S&P Index on the other hand had returns of $188,765, crushing the highest earning advisor by $30,000. That's right, a fund left passively managed beat 5 advisors that managed funds actively. Note, this is excluding fees that fund advisors usually charges. With fees included, the profit margin is much less.

Just to note, even if both funds were to profit at an equal percentage annually, the S&P Index still crushes active funds by a huge percentage. Don't take my word for it, take John C. Bogle's (Founder of Vanguard Group, which at present has one of the smallest expense index fund) word. In his heavily worded letter to the New York Times about this competition, he mentions:

"Put another way, the advisers earned a seven-year profit for their retirement plan investors of $88,500, compared with $138,750 for the index fund. That $50,000 difference is enormous -- equal to the entire initial investment. But it understates the reality. For, given the magic of compounding, even if the fund advisers and the index fund were to earn an identical, say, 10 percent a year over the next 13 years, the final value in 2013 would be: average adviser, $478,000; index fund, $652,000."

That's right, the index fund crushes any actively managed fund, and mostly not just due to bad fund switches, but to exorbitant fees charged for managing those funds.

There are advisors that has outperformed the index fund, but they are rare. I won't discount the fact that an advisor can defeat an index fund, but I would learn my lesson from the 90% that doesn't. If you were to argue that "my advisor has beaten the STI Index for the past 3 years", it's definitely possible. But considering the fees, he/she has to beat the index by 3-5% (or even higher) just to generate the same returns after fees payable. Also, past performance is never indicative of the future, so be wary of this.

So, what is an ETF?

Now that you know what an index fund is and why it's probably better than an actively managed fund, here's the main differences between and ETF and an index fund.

An ETF tracks the performance of an index fund to the closest it can (probably off by a very small percentage point most of the time). However the main difference is that they are listed on the market and can therefore be traded like stocks. This means that the prices can go up and down throughout the day and provides liquidity, and similarly they can be bought or sold throughout the day (although doing that would be foolish). Also, it is sold in smaller sizes than index funds, which allows small time investors like us to share a piece of the cake.

Index funds however, can only be marketed once a day, at the end of the day when the market closes. It is normally sold in larger sizes so you would need bigger capital.

Retail investors like me and you should typically choose an index fund over ETFs as the costs are generally lower, however they may be a little more troublesome as it cannot be sold as and when during the day (which is not an issue because we want to invest for the long term) and may have documentations and accounts to be set up before purchase.

In my view, since an ETF mirrors an index fund, both are great options (and are technically the same) and it's up to the individual to decide which he/she wants based on cost, capital and how hassle-free it is.

Conclusion

I would choose an ETF for now as it fits my investment commitment monthly and the fees are not too far off compared to an index fund. Also, it is hassle-free and can just be sold as and when I like it to, which is a huge bonus for me. Personally, I feel that the differences are almost insignificant and to decide which is better, the main point is always to figure out which costs lesser. However for me, I'm supportive of an ETF just because it is more flexible, but it's totally up to you. Small cost difference in exchange for flexibility, I'll take it!

In my next post, I'll share about the bonds, and how I allocate my bonds and index funds. Stay tuned!

Comment if you have questions, opinions or feedback!

-WC

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Insurance: How Much Is Enough?

by Unknown - 00:05

The Main Purpose

At the first thought of insurance, most Singaporeans probably think of those financial advisors by the road or shopping malls pulling you over to do a quick survey, or inviting you over to their booth to listen to what they have to say with no obligations to purchase anything.

Some people give in and start considering what to buy, but here's the thing. If it's getting covered, I personally have no qualms in buying such products to secure me for a unforeseen circumstance. However, I've shared in an older post why I would not mix insurance with investment. However, it is up to you to decide if you are able to do that as well, because every individual has different circumstances and my decision may not be right for your situation.

However if you ask me, there's only three types of insurance products that I would purchase when I've just started working. As a personal rule of thumb, anything above 10% of my income to pay for insurance policies is over my budget. Let's see what I would get.

1) Term Plan

2) Hospitalisation Plan (a.k.a Integrated Shield Plan/ISP)

3) Accident Plan

Term Plan
Term insurance is basically insurance that covers you for a fixed period. After the age of 65, the coverage gets costly. This is why I am only covered until age 65. As it has no cash value (i.e no savings/investment component), the policy is generally cheap. However, you are technically paying them for 'free' if nothing happens to you.

The money you save on getting term compared to getting a whole life policy should be invested so that you can generate returns to build your retirement nest. The only reason I am covered until 65 is to have some money left behind in the event that I pass on and my dependents have no money to lead a proper life. Past age 65, I only have to be concerned for myself and being covered by a hospitalisation plan is more than sufficient.

However, this is my personal ideal. If you like something with cash value or disciplined savings, a whole life plan may be suitable. For people like me who prefers to generate passive income on our own, it is generally not recommended to get a whole life.

The main aspects of coverage would be Death, Total Permanent Disability (TPD) and Critical Illness (CI). Some people also prefer to get covered for ESCI/ECI, Early Stage Critical Illness. I don't for two reasons: If I require treatment in the hospital, I am covered by my ISP, and it is very costly to get covered for ESCI, which can nearly double your premiums for a term plan. How much coverage you need is dependent on your personal goals. For myself, I am insured 500k per aspect. Just a reminder though, for CI, always check what types of CI are covered by your insurer before purchasing it.

Most agents would not recommend a term plan because the commission they earn is much lesser compared to a whole life. However, should you want a term plan, stand your ground and insist on what you want. It's your money, not theirs. If you think a whole life plan is worth listening to, go ahead by all means.

Hospitalisation Plan / ISP

I've seen friends who've gotten ILPs, endowments and every common plan agents like to throw to them. But when I ask them if they have an ISP set up, most would say 'I didn't know about this'. That's preposterous. If you were to get hospitalised without an ISP right now, can you afford to pay the bills?

An ISP is cheap (though it rises in accordance to age) and is a must get in Singapore. There are two components, one is deducted via your Medisave Account and the other is paid by cash. Generally the cash component is cheap and affordable, and should not cost you more than $40 - $50 per month, most of the time lesser. By choosing the right type of ISP, you are covered for most hospitalisation charges like surgery, warding and consultation etc. The type of ISP that suits you is really dependent on what you prefer. If you only want to stay at Class B Ward and above, you need to get an ISP which insures you for that. Look around for an ISP that suits you, just because it's cheap doesn't mean that all ISPs are the same. You can get a better deal for the same premiums most of the time.

You can look at the available plans here, on the MOH's official website.

Accident Plan

I've spoken with some of my friends, colleagues and investors who share a common goal with me. The opinion on whether an accident plan is necessary or not is split almost evenly. Some do not see the need for this plan as the term plan and ISP covers both possibilities of an accident. In death or TPD, term plan covers the payout, and in the event of hospitalisation, ISP covers it.

However, I did purchase an accident plan for myself. The primary reason is that because it's cheap, and also certain conditions of an accident does not warrant a payout by the term plan, for example, loss of a finger. The chances are low, but the purpose of insurance if to be covered for the unforeseen future anyway. Get it or not, it's up to an individual's opinion.

Conclusion

Most financial advisors do not recommend these 3 products when they first meet their clients (because of the commissions). It is only offered when you ask about it and even then they will probably market a whole life policy or ILP with insurance coverage. However, always remember the costs and fees involved. Your money would probably fare better in an index fund.

If you don't know the benefits of index funds and bonds to create a stable portfolio yet, the least you could do is read up a little on it, and refrain from buying policies that lock your money for decades unless you feel that you need this sort of forced discipline. I'll share in the next blog post about ETFs, index funds and bonds. Stay tuned!

Comment, questions, opinions? Leave a comment below!

-WC

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Avoiding Seductions in the Market: When Something Sounds Too Good To Be True

Removing Limiters: My Observations

Index Revolution: Why Investors Should Join it Now

My Strategy To Invest: Adopting the Couch Potato Portfolio

The Other Half Of The Pie: Bonds and Bond ETFs

When Being A Couch Potato Pays Off: ETFs vs Index Funds

Insurance: How Much Is Enough?

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