Date: September 7, 2020
First published in Straits Times on 6 September 2020
Diversify, understand the risks and know the product you are putting your money into
“Don’t put all your eggs in one basket” may be a bit of an investing cliche, but proper application is critical to ensure risks are spread out over a variety of investments.
Back in the 2008 Lehman Brothers minibond crisis, Securities Investors Association (Singapore), or Sias, encountered the case of a retiree who had put her entire retirement fund of $560,000 into the minibond.
She was invited to a social dance by a young relationship manager who told her on the dance floor that Lehman Brothers bank was six times bigger than DBS Bank, and that she would get 6 per cent guaranteed returns.
She was excited because her money in a fixed deposit account was earning 0.55 per cent interest then. But after six months, when Lehman Brothers went bankrupt suddenly, it appeared that her entire investment was lost.
She was devastated and approached Sias in desperation to get her money back from the bank, which sold her the minibond.
We managed to recover for her, with the help of the Monetary Authority of Singapore (MAS), the majority of her investment.
She was somewhat fortunate because there were thousands of others in her predicament.
THE NEED FOR DIVERSIFICATION
Her anxiety could have been avoided if she had diversified her portfolio. For example, placing her money in four or five different investments or asset classes.
The problem was that she did not know anything about investing. She heard of Sias only because her friends directed her to us.
My first question to her was why she had ploughed all her savings into one investment and whether she had ever attended any investor education class.
She said she was a teacher herself all her life and taught hundreds of children, but had not taught herself how to invest.
She could not be blamed because financial literacy was not part of the school curriculum until only recently.
The sharp fall in stock prices around the world when the seriousness of the Covid-19 pandemic was first acknowledged in March, and the swift bounce that ensued has tempted many retail investors to try their luck dabbling in the market.
I have previously explained the risks of short-term trading and investing without knowledge.
The teacher’s experience should be an eye-opener for those entering the market blindly – it is essential to stick to the tried and trusted principles of investing rather than following others and punting the market.
UNDERSTAND THE RISKS
The first is to diversify. The second would be to understand that higher returns come with higher risks and the investments that offer superior returns will surely be accompanied by greater risks.
Investors must know how much risk they can bear, otherwise they may find themselves buying unsuitable products or stocks.
You must know the product you are investing in, its features and risks. In the case of Lehman minibonds, if even the financial professionals had difficulty understanding the underlying risks, then how could the small investors?
Thanks to the MAS, in the aftermath of the minibond saga, issuers now have to summarise all the risks and features in the product highlight sheet.
Sias introduced the 10 questions for investors to ask their bank relationship managers, especially if they are investing in structured products.
If you do not understand the investment product, then do not invest. Just walk away!
Younger investors have a longer runway ahead of them to work and, therefore, absorb investment losses that might be suffered in the years ahead.
In theory, this means they can take on more risk and, therefore, invest more in stocks, but, as noted earlier, this really depends on the individual’s risk profile. Investors with a shorter runway should ideally focus on capital preservation and invest in safer instruments such as bonds.
THE LONG TERM AND HOLDING POWER
Studies of stock markets over many decades have shown that given a lengthy time horizon, stocks will outperform bonds.
The amount of outperformance will vary according to the timeframe chosen, but research suggests 5 per cent to 8 per cent above the risk-free rate is possible for holding periods of more than 10 years.
Our research has shown that the probability of succeeding in an investment is around 75 per cent at the 10-year mark.
Much, of course, depends on individual holding power.
In this connection, investors should make sure they:
- have sufficient savings in the form of an emergency fund of at least six times their monthly expenses;
- are properly insured; and
- try as far as possible to use only money that they can afford to lose when investing in markets. They should at all costs avoid borrowing to invest.
QUALITY AND VALUATIONS MATTER
During the heyday of Clob International and during the dot.com boom and bust in the early 2000s, it became common for investors to ignore valuations in favour of supposedly attractive future prospects.
In other words, it didn’t matter that Malaysian companies on Clob or Internet companies whose prices were running high had no earnings or fundamentals as long as they could spin a convincing story about the potential of superior earnings in some distant future.
In the case of Clob, a popular theme was infrastructure, which fired the imagination of investors because of the large sums involved in building dams, highways and bridges.
For technology firms, the Internet was a new and novel development and investors were sold on the idea of vast riches because a company’s market was no longer confined to its home, but instead would encompass the whole world.
Investors should be wary of this type of investing, which is essentially pure speculation that might in some cases produce good results but comes with an inordinate amount of risk.
In times of crisis such as now, it would be far more advisable to look for good-quality companies with strong balance sheets and proven track records that would enable them to stay afloat, instead of speculating on expectations of vague profits in some unknown future.
Scammers are aplenty nowadays, with promises of mind-boggling high returns.
Investors should always bear in mind that if it sounds too good to be true, it probably is. Always ask, check and confirm before forking out your hard-earned money.
The message is very clear, even if this time is different in the sense that Covid-19 transcends any crisis ever seen in the past 100 years – the approach to investing should not be any different.
Stick to the basics to ride out this period – it should stand you in good stead.
• The writer is David Gerald, founder, president and chief executive of the Securities Investors Association Singapore.