“The best time to plant a tree was 20 years ago. The second-best time is now.” This popular Chinese proverb also applies to investments. The global COVID-19 outbreak presented a rather rude awakening for many Singaporeans to explore how they can improve their personal finances.
Most people still think that they need to have plenty of funds to start investing in Singapore, particularly in the stock market or stock exchanges. On the contrary, you need to determine your long-term goals and risk appetite when planning to invest for the first time.
Plan Your Long-Term Investment Goals
How long do you plan to keep your money tied to your investments? Do you have a back-up plan if things go south? While it’s better not to think about investing money that you’re willing to lose, some financial experts believe that having a safety net for your long-term investment objectives remains important.
Take the coronavirus situation as an example. Most investors weren’t expecting a pandemic that has affected almost every industry in the world, but the reality is clear that those who have a buffer with their investments won’t be as heavily exposed as investors who didn’t have a contingency plan.
Check out the Short Term Endownment Plan for Saving
4 Simple Ways To Determine That You Are Ready To Start Investing
Some people who already have a back-up plan, however, still become uncertain if they are ready to start their own investments. How should you know if you’re ready? There are four simple ways to determine for yourself:
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Be Debt-Free
This seems easier said than done but unfortunately, it’s not prudent to invest money when you’re struggling to pay off debt or even the interest from a personal loan. You can still simultaneously dabble into investments while settling your loan payments, provided that your debt remains manageable.
For instance, you may have an existing home loan where you use CPF to cover the monthly payments or your investments can yield a monthly return that’s above the actual interest rate of your loan. Being debt-free also prevents you from liquidating your assets to pay off loans.
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Have an Emergency Fund
You may be debt-free, although your savings account shows a zero balance. You’ll be fit to pursue an investment once you have at least six months of your monthly income for an emergency fund, which might be the most critical part of your contingency plan.
An emergency fund protects you from selling your investments at a loss in a bear market (e.g. during an economic recession or when a market goes through a prolonged crash). It also prevents you from taking on new debt to cover your expenses in case you lose your job or primary source of income.
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Be Patient
First-time investors mistakenly think that they can recover their investments after a few years. By definition, long-term investments typically require at least five years of waiting to reap the returns. Short-term capital gains are rare, and you’re almost bound to lose money if you only want to invest within several months.
Why is it necessary to leave your money for that long? The primary explanation involves core inflation, which ranges to 2% to 3% per year in Singapore. If you’re only willing to invest with an expectation of liquidating it after less than five years, it’s almost likely that you won’t make money, or worse, lose the amount altogether.
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Conduct Due Diligence
Due diligence doesn’t have to be complex. Novice investors, however, should be willing to dedicate time and effort to understanding the basics of investments.
There are different asset classes and while you don’t need to study each one, it pays to review your chosen investment vehicle and the accompanying risk level.
What Is Your Comfort Zone?
Risk levels can be divided into three types comprising low-, medium- and high-risk investment options. Savings bonds are an example of a low-risk financial instrument, while blue-chip stocks and equity mutual funds are examples of medium-risk investments.
Most high-risk investments include hedge funds, foreign exchanges and the recent trend on cryptocurrency investments. Each risk level has its own pros and cons.
As an example, exchange-traded funds (ETFs) are defined as high-risk and high-return investments.
A rule of thumb to remember: a higher potential yield on your investment always carries a high level of risk. When you purchase a stock of an ETF, you simply buy from a collection of weighted shares. The Straits Times Index (STI) is an example of an ETF that has the top 30 stocks in Singapore, including DBS, OCBC and Singtel.
The primary benefit of investing in an ETF is that you actively trade at a benchmark, which refers to the rate of return that’s fixed to market conditions. In other words, it’s possible to achieve a consistently upwards rate of return when the market performs well. The STI ETF has expanded by more than 2.9% between 2013 and 2019.
In the future, though, ETFs may be a safe haven for investors who want to ride out the upcoming bear market brought by the coronavirus outbreak. The diverse range of stocks means that you can limit your risk exposure to the volatility of shares. Unit trusts, which are also known as mutual funds, also involve high risk and potentially high return.
The primary advantage of investing in unit trusts is the potential for outperforming the benchmark return of the index market. Take note that you entrust the decision of investing under the responsibility of fund managers, who are supposed to navigate the market expertly. Hence, investors in mutual funds pay a fee of 0.5% to 2% per year to fund managers in exchange for handling the pool of money (i.e. the funds).
Both ETFs and mutual funds involve a low effort on the part of investors, meaning that you don’t have to conduct a lot of research except for vetting the competency of a fund’s managers and understanding the basics of investing in the market. The same applies to low-risk investments such as bonds, although the primary difference lies in the moderate risk and return.
Bonds, especially those from the Singapore government, are a financial instrument that allows the issuer to borrow money. Aside from the government, corporations also issue bonds to raise money for business operations.
The risks of buying debt securities issued by the government are inherently low, simply because there is a small chance of default on the government’s part. Bonds from established companies like OCBC and Singtel also involve a moderate level of risk given that these companies are not expected to become bankrupt easily, which is a primary factor defaulting on their loan obligations.
When you purchase bonds from the Singapore government or a huge corporation, there’s usually a predetermined interest that serves as the income for investors who invest their money. The issuer pays the interest in regular intervals, normally every year, until the bonds’ maturity.
One of the main disadvantages of investing in bonds involves a buyback or redemption option by the issuer. The Singapore government or public company can choose to buy the issued bonds before the maturity date, hence limiting the amount of return that you can receive from the investment.
Interest rates and bond prices are also related, and there’s the risk of reinvestment at a significantly lower rate in case of free-falling market rates.
Diversify Your Investments
Let’s say you plan to use $1,000 or less to start investing, but you also want to diversify your portfolio. Investment diversification remains important simply because you don’t want to lose all of your money in an instant. As the saying goes, putting all of your eggs in one basket can be risky if that basket drops and damages the eggs.
Some of the best ways to diversify your $1,000 in investments include the Singapore Savings Bonds, the STI ETF and blue chip stocks. You can use a regular savings plan to invest as low as $100 in the latter two investment options, while the Singapore Savings Bonds requires a minimum of $500 when you invest via its website.
Real estate can be another good choice for diversification, particularly real estate investment trusts (REITs). Most types of REITs own income-generating properties such as office buildings, hotels and residential apartments. Choose at least three investment vehicles to spread your balance your risk exposure and potential investment returns.
A word of caution: high-risk investments don’t necessarily mean that you will get an equally high yield. In some cases, investors lose all of their money even with one miscalculated decision, so you should think carefully about where you place your capital.
You can narrow down the criteria for diversifying your investments by making sure that your portfolio has exposure to different geographies, maturity dates, industries and structures.
The Power of Compounding Interest
You may have heard about the benefits of the “dollar cost averaging” as the best strategy for first-time investors. This scheme requires a regular purchase of a certain investment, like stocks for example, at a fixed dollar amount in spite of the price.
It works best for those who don’t want to monitor the market frequently, but it’s worth considering to think about how compounding interest can make your money work harder for you.
While everyone can use the strategy of compound interest, this method benefits those who start early since time is a crucial factor for success. So what’s the logic behind compound interest? It refers to the calculated interest based on the sum of the initial principal amount and the accumulated interest.
A simpler illustration is this: You plan to invest $10,000 every year with an 8% interest rate. After the first year, the amount may earn $800.
The calculated interest during the second year will be based on the new balance of $10,800, which means you will receive $864 as interest payments. By the third year, the interest payment will be calculated based on the amount of $11,664.
You can easily see how the money grows over time and the longer you keep your money invested in the market. The actual interest rates vary among different options, although mutual funds are an example that can give you a net return of 6% per year.
We’ve mentioned time as either your ally or antagonist for using the power of compound interest.
That’s because a person who starts investing in their 20s will earn more than someone who decided to do so in their 40s. Based on the 6% per annum net return, a 25-year-old individual will only need to invest $450 per month to achieve a $1 million retirement fund by the age of 65.
If the person starts at 35 years old, then the monthly investment amount doubles to $950 to achieve the same retirement fund. The required monthly investment exponentially increases to more than $2,000 if the individual starts investing at 45 years old.
The Market Will Always Have Its Ups and Downs
History has shown that the market always recovers after a recession. The current pandemic may be dampening consumer confidence right now, although it might be a good time to get started while prices remain on a declining trend.
This is particularly true for stocks, as the concept of buying low and selling high is a straightforward approach to stock market investments. Another important factor here is the long-term growth of the company. Shareholders of food manufacturers, for instance, know all too well that a pandemic can’t affect the industry as much as other sectors because people will need to eat during whatever crisis.
Conclusion
It’s easy to feel emboldened when you’re finally taking the plunge into the world of investments, but you shouldn’t let your emotions take control of your decision-making skills. If you already chose an investment vehicle that works for you, then the next step involves the necessary capital to jumpstart your investment journey.
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