| Brilliant Ways To Make Your Investments Work Harder |
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By Leong Sze Hian
If your starting point for investment is just $1, life is easy! You can only go up. Realistically, most people start in the middle – about $10,000 to $20,000. But with the overload of financial information in the marketplace, people sometimes prefer to do nothing because they fear to lose their money due to a bad investment decision. Most people just leave their money in the bank, or CPF account earning normal returns. Where’s the best place to put that money? What are the ways to make the most of your money? Your financial adviser will say that the “best investment” for your money will depend on the risks you’re willing to take. And in today’s unpredictable stock markets, chasing short–term returns is only for people who can afford to lose. The prudent thing to do will be to take a long–term strategy that tries to minimize risks and receive reasonable returns.
START WITH SELECTING A DOZEN FUNDS Have you been worried about all the unpredictability about the stock market? As long as you have developed a diversified portfolio, you will be able to grow your wealth. The concept of diversification is common to most investors. The main goal in the strategy is to improve your investment performance while reducing the risks. Your first step is to simply select about 12 to 15 funds. The portfolio must be globally diversified with some exposure to the United States which accounts for about 50 per cent of the world’s capitalization. Moreover, make sure you have some sector diversification like technology stocks.
That said, let’s look at an important strategy that includes having more higher risk type of funds in your diversified portfolio. Single country funds like China, India, and Japan will add more depth in your overall diversification strategy.
Diversifying the portfolio also means looking at the fund manager and their fund management style. There is no rule against selecting all the funds from the same fund manager or the asset management company. However, it is important for everyone on the team to have a high level of expertise and share the same investment philosophy or commitment.
LOWER THIS COST OF YOUR INVESTMENT Before you buy a fund, check out the fee charged and expenses. Understand the initial and ongoing costs involved in the investment. Look for a fund with low or no front–end load. The load is usually included in the first payment made by the investor. This usually translates into an initial higher payment and later in lower payments. The purpose of a load is to cover the administrative expenses and the transaction costs. It is deducted from the investment amount and lowers the size of the investment. In addition, this is sometimes used to discourage asset turnover or frequent trading of the fund which can hurt a fund if it has to hold large cash reserves to meet payouts.
Still, you will likely not realize how much 5 per cent will affect your portfolio. For example, if you buy a no–load fund for $50,000, then the total amount of $50,000 will be used to invest in the fund. However, if there’s a 5 per cent load charge, then your investment amount used will be reduced to $47,500. Moreover, after a few years when your fund achieves a 9 per cent return, the no–load fund will have grown to $54,500. However, the fund with the load will return a lesser amount at $51,775.
While there are some funds that don’t charge a front–end load fee, investors will still pay an extra annual fee for marketing and managing the fund. This is added to annual expense ratio. In most cases, investors will be worse off because the extra one per cent charged per year will eat into their investments perpetually. Moreover, the real “no front–end” load fund is worse off than a normal “front–load” fund if you sell your fund before three years. After five years, the investor who bought the “no front–end” load fund will not need to worry about the higher fees.
BALANCE YOUR FUNDS TWICE A YEAR AND SWITCH FREE The real effort, however, is yet to come. You will have to balance your fund by switching. Specifically, this principle involves buying low and selling high. This has to be done about once in every six or 12 months. The performance of all the invested funds would vary — the returns would have gone up, doubled, fell, or perhaps stayed the same. It takes some effort to go through the process of rebalancing as it forces you to take profits, and reinvest in undervalued categories.
Most investors are not patient and instead do the opposite. They buy “hot funds” or best performing funds at their peak. Essentially, they end up buying high and selling low. The concept of value averaging is also used here. This investment strategy is designed to reduce volatility and encourages the investor to buy more funds that have marginally increased in price, or fell. Moreover, it advocates selling your funds and take your profits.
ACQUIRE FUNDS WITH LOW EXPENSE RATIO The accepted annual expense ratio of a fund should be around 1.5 or slightly more. But what is the expense ratio? It primarily includes the costs of all the overheads for managing the fund such as managers and employees’ salary, bonus, and rental, advertising, and travel etc. It tells you the fees as a percentage of your net assets. For example, 0.5 per cent expense ratio will mean that you’ll be charged 50 cents for every $100 of net assets.
For example, suppose you wanted to invest $10,000 in either Fund 1 or Fund 2. Both funds are expected to deliver an annual return of 5 per cent. Comparing the two funds, refer to Table 1 for the fees you would pay.
FINDING THE RIGHT TIME TO CHANGE FUNDS This investment idea of changing your funds is different from “rebalancing”. Changing funds means either shifting your investing objectives, This investment idea of changing your funds is different from “rebalancing”. Changing funds means either shifting your investing objectives,
MAKE YOUR WITHDRAWAL WHEN YOU NEED THE MONEY Sometimes when markets are down, investors start to panic and immediately withdraw their investments. However, their actions eventually perpetuate a vicious circle whereby investors will always suffer loses. Buying into a fund is like buying into market. No matter how far the prices of the funds have fallen, the prices will eventually have to come back up. In reality, the loss is still a relative term because you will never sell anything at loss. The idea is to keep rebalancing and take profit from those funds that have gone up more, and buy more of those funds that went down. Due to the laws of downward averaging, one day when the funds start to rebound, you’ll make hefty returns.
When you need money, then sell the fund that goes up the most. If you need the money, sell the fund that has gone up most in annualized returns. In this way, you will always be exceeding the average market returns. That is, you will be buying low, and selling high.
CENTRE STUDIES SAY THAT YOU WILL NOT LOSE MONEY What if 10 out of the 12 selected funds lost money? Should you continue to use the same strategy? The answer is yes because of the diversification process. An asset allocation of 60 per cent equity and 40 per cent fixed income (bonds) determines a negative correlation. Normally, when equity prices fall, the bond prices may rise. Diversification in different regions, countries, sectors and with different fund managers will also make sure that you are minimizing your risks.
The Centre for Fiduciary Studies using data from the MorningStar reported that this type of portfolio produced an average return of about 8 per cent per annum, over historical 5–year periods. The range of returns for a period of five years is about 2 plus to 13 plus per cent per annum. In addition, studies beyond 10 years, the historical probability or risk of getting returns of less than 2.5 per cent is less than five per cent.
GET HELP IF YOU NEED IT For each of these suggestions, you can then choose to consult your financial adviser to find out more strategies. However, remember financial advisers do their best work when you are willing to share your confidential financial information. So, it is still your call. But now you can make an informed choice.
LOWER THIS COST OF YOUR INVESTMENT Before you buy a fund, check out the fee charged and expenses. Understand the initial and ongoing costs involved in the investment. Look for a fund with low or no front–end load. The load is usually included in the first payment made by the investor. This usually translates into an initial higher payment and later in lower payments. The purpose of a load is to cover the administrative expenses and the transaction costs. It is deducted from the investment amount and lowers the size of the investment. In addition, this is sometimes used to discourage asset turnover or frequent trading of the fund which can hurt a fund if it has to hold large cash reserves to meet payouts.
Leong Sze Hian |