Date: February 17, 2021
First published in Straits Times on 14 February 2021
Knowledge and education are the fundamentals that will help investors
As we usher in the Year of the Ox, many are hopeful that 2021 will be better than the one that has just passed.
There is ample cause for optimism – several countries have started mass vaccinations against Covid-19 which has brought the global economy to a standstill, China’s economy is showing signs of life, there has been a cautious return to some air travel and, for Singapore, the latest non-oil domestic export numbers surprised on the upside.
The biggest positive is that interest rates are expected to remain low, monetary policy will stay accommodative and, over in the US, the incoming Biden administration is planning a massive stimulus to kick-start the economy.
But all is not rosy. Rising complacency in many countries has led to second and third waves of infections that are, in some cases, worse than the first. Europe is now struggling to contain the rapidly spreading disease, while in the US, there is very real danger that the pandemic may be raging out of control.
Given such an outlook, what should investors do? They should not stray too far from the fundamentals. Before investing, make sure you have sufficient emergency funds, at least six times of your monthly expenses. Plus, here are five things you should do this year:
Have a plan and review it regularly
It is important to pay attention to your investment objectives, which, in turn, are linked to the stages of your life. Younger investors have plenty of time on their side and can buy and hold riskier assets for the longer term, thus riding out the inevitable short-term volatility that markets will always undergo.
Older investors, on the other hand, are advised to hold safer, less risky assets that may not offer much growth but instead provide a steady stream of modest income while preserving their capital.
In addition, those in their 50s and above have much less time on their side to continue earning income from employment should they lose a large sum in the market. So they should be mindful of placing too much of their retirement nest eggs in risky investments.
This means that you need to consider liquidity, safety and returns.
Once your portfolio has been constructed, it is important to regularly review and rebalance it. Ask yourself why you bought a particular stock or bond and whether there are good reasons to continue holding it.
This will help you to check if the investments are on track to achieving your goals. You should do this even if you are a passive investor who invests mainly in unit trusts or funds that track indices. If you can’t do the above, then you should seriously consider seeking the help of a licensed financial adviser.
Stay invested and make use of compounding
When buying stocks, investors are advised to buy and hold shares in good companies and to hold them for the long term. Many investors try to time the market and indulge in short-term, possibly daily trading, thinking that this is the route to making money.
The problem is that being able to do this well consistently is very difficult for most of us – most of the time, investors follow the crowd and end up panic selling as well as panic buying. Research has repeatedly shown that those who try to beat the market through short-term trading invariably end up losing money.
Investors should also bear in mind the benefits of compound interest, or interest on interest. A simple way to see the power of compounding is to use the “Rule of 72”. For example, if an investment offers 4 per cent annual compound interest, then any sum invested at this rate will double in 72/4, or 18 years.
It has been shown that when a couple aged 30 top up their Central Provident Fund (CPF) Special Accounts to $130,000 each, their accounts will grow to a combined total of $1 million by the time they reach 65. In other words, both will enjoy the power of compound interest because the CPF Special Account pays a minimum of 4 per cent. This should be an eye-opener for young couples.
Make use of dollar cost averaging
In simple terms, this means investing a regular sum at fixed intervals, regardless of market conditions or prices. This is because over time, investors will achieve a lower unit cost. It also has the added advantage of ensuring that you remain invested over time.
In effect, this strategy neutralises short-term volatility and removes much of the detailed work of attempting to time the market in order to make purchases at the best prices. Most regular savings plans offered by financial institutions work on this principle.
Manage your risk
Investors should always pay attention to risk and not just potential returns, such as what will cause a loss to their investment and whether they can stomach it. Depending on one’s age and financial commitments, our advice would be to ensure that there is a sufficient weight given to lower-risk assets like investment-grade bonds so that the portfolio is balanced.
For stocks, it might be a good idea to also have a mix of low- and high-beta stocks, beta being a measure of how correlated a particular stock is with the broad market.
In other words, a high-beta stock would move by a larger amount than a low-beta stock when the market moves in any particular direction. A high-beta stock is therefore described as being riskier.
Diversify
Put simply, don’t put all your eggs in one basket. This happens to be one of the most important strategies that investors can employ to reduce their risk, and requires investors to diversify across asset classes, countries and sectors.
Try not to have your portfolio too heavily exposed to one sector or country, or even asset class. For example, many observers expect the travel and tourism sectors to recover in 2021 since hopes are high that life will soon return to normal and travel will resume.
This may well turn out to be an accurate expectation, but having too much invested in travel and tourism will expose investors to risk of a large loss if the recovery does not materialise or if more countries are forced to shut down for longer.
Investors should also pay attention to possible investment themes. For example, there is a powerful push towards ESG investing, on environmental, social and governance factors. Issues such as climate change are gaining traction and investors would be well advised to familiarise themselves with the considerations that surround this new and exciting field of investing.
If you do opt for sustainable products, the advice is still the same – have a plan and review it regularly, stay invested for the long term, make use of dollar cost averaging, pay close attention to managing your risk and diversify.
Remember that knowledge and education are vital for investing. At the end of the day, it’s the fundamentals that matter.
- The writer is David Gerald, founder, president and CEO of the Securities Investors Association (Singapore)
