Financial Chickens

There are three main choices when it comes to investing for Singapore investors: Stocks, Bonds, Cash and Property

There is no one size fits all approach to asset allocation and the right asset mix will depend on factors such as:

1. – Age
2. – Risk Tolerance
3. – Comfort with Volatility
4. – Ability and willingness to leverage
5. – Length of time until retirement

Here’s our own guide that aims to help you make a better informed decision on the right asset mix for your portfolio by discussing each asset class in turn.

Allocation to Stocks / Equities

There are plenty of options when it comes to investing in stocks which range from assembling your own portfolio of individual stocks or buying unit trusts or ETFs.

The challenge most investors will face is not a lack of choice but information overload from there being too many choices!

You can read more about investing in stocks specifically in our article – “How to Invest in the stock market”,

Outside of property, stocks generally represent the largest investment allocation for most investors. There are several “conventional wisdoms” that apply to asset allocation for stocks.

Age is one of the chief criteria, and the general idea is that you should have a larger allocation to stocks when you are much younger as you have a longer time horizon to ride out short term price fluctuations. You get to benefit from the power of compounding.

As you grow older, you begin to reduce your allocation to stocks and start shifting it to more stable assets like bonds which generally offer lower returns but tend to be less volatile and that provide a steady stream of income.

One simple rule of thumb is to subtract your age from the number 110 to determine the right allocation. For example, if you are 30, then the rule will dictate that 80% of your portfolio should be in stocks.

Other frameworks a 50-50 stocks/bonds portfolio for balanced investors, a 75-25 stocks/bond portfolio for aggressive investors and a 25-75 stocks/bonds portfolio for conservative investors.

Our Take on Stocks

Such frameworks are useful as a rule-of-thumb. However, investors should assess just how comfortable they are with the volatility that is inherent in the stock market.

With the advent of smartphones, we’ve observed investors becoming more and more in tune with the day-to-day fluctuations of the stock market and trying to jump in and out to avoid market lows and to ride market highs.

One reason is the discomfort with bad news and the accompany decline in share prices. Its important to note that intra-year declines of 10% to 20% are not uncommon (nor should they be regarded as being “abnormal”).

Investors who are uncomfortable with such declines should target a lower allocation to stocks as repeated trading will drive down overall returns dramatically.

Bonds / Fixed Income Instruments (e.g. Preference Shares)

Investors tend to invest in bonds because they offer less volatility than stocks and produce a reliable stream of income.

There are two main type of bonds available to investors – Corporate Bonds and Sovereign bonds.

Corporate bonds are issued by companies and Sovereign Bonds which are issued by countries. You may also have Corporate Bonds issued by State Owned Enterprises that have the implicit backing of the state because it is the company’s largest shareholder.

Investors can also invest in bonds through bond funds.

Our Thoughts on Bonds

1. High quality bonds often offer low yields

There is a relationship between risk and return that investors must understand when it comes to bonds:

1. The higher your interest, the more risk you are inherently taking
2. Risk can involve default risk (losing your initial capital), duration risk (taking longer maturity), weaker covenants

Interest rates are at record lows because of central bank intervention post the Great Financial Crisis. Our general observation is that investors looking for high grade investment bonds with short durations of less than 5 years are generally stuck with yields in the region of 2% to 3%.

So, for the average investor who wants to invest in high quality investment grade bonds with reasonable durations (3 years) is stuck with very low yields.

The Chase for Yield is Highly Dangerous if You Don’t Know What You Are Doing

Yield compression around the world has many investors “stretching for yield” to earn a decent return to try to match inflation at the very least.

Even with a million dollars, a 2% yield will only provide $20,000 of income that will be deeply unsatisfying for most people. The fact that investors would seek higher yields is unsurprising.

Unfortunately, free lunches rarely exist. Higher interest rates equate to more risk even if investors do not realise it.

This implicitly investors are taking are taking a greater risk with their initial investment to generate an extra percentage point of interest.

This may all sound very theoretical – but sadly, it is not.

In the last few years alone, almost US $15 billion of bonds and loans alone have fallen into distress in South East Asia. Areas of significant financial distress have included the Oil & Gas Sector in Singapore.

Perhaps the most high-profile mishap has been Hyflux which saw retail investors suffering huge losses when they invested heavily in their Preference Shares.

Property / Real Estate / Investment Properties

Property by far has been the greatest generator of wealth for many Singaporeans in the last three decades. Stories of property prices going up by dramatically (multiples) are not uncommon.

And yet, the empirical evidence shows that real estate underperforms stocks. Just what is happening?

Source: https://www.todayonline.com/singapore/which-are-better-long-term-investments-properties-or-stocks

Leverage is Key To Investing in Property

One of the biggest things unique about investing in property is the amount of leverage that investors can utilise.

** In this simple example, we are just going to assume that there are no transactional costs and that your interest cost is fully offset by any rental income. Any gains are coming from an increase in price.

In this hypothetical example, the investor has borrowed $800K and injected $200K of his own capital to buy a property worth a $1 million.

A 20% increase in price leads to a doubling of his initial investment of $200k to $400K. Such is the power of leverage when it comes to property investment given a bank’s willingness to loan against “hard asset”.

Of course, there are risks inherent with leverage. As anyone will tell you, it is a two-edged sword. The fallout from the Great Financial Crisis of 2008 led to a situation whereby many investors where in negative equity (their house was worth less than their loan) in the US.

Thanks to timely interventions by the government and central banks, such a situation has not troubled Singaporean investors much since the Asian Financial Crisis.

Cultural Attachments to Real Estate

During my talks, I often jokingly refer to the case of a Chinese businessman who makes his money from business, invests in money into property and gambles in the stock market while telling his family he is investing.

While this is in jest, it is not too far from what is happening on the ground.

During the course of my work, I have spent a lot of time with individuals and the one thing that strikes me is how few people have come close to even earning what the theoretical returns of the stock market are. They number less than the fingers on my hand.

At the same time, most individuals will reflect that their property investments and first home have been the greatest generator of wealth over their lifetime.

Most Investors in Property are By Default Long Term Investors

People who own their own homes (which in Singapore’s case is the majority of the population with HDB) are by default long term investors. You don’t hear of people “trading in and out” of their main residential property.

The majority of people do not take undue risk and play around with their main asset.

Likewise, people who invest in property have an intuitive understanding of what investing in property is all about and are well within their “circle of competence”.

When prices decline, people tend to rationalise it but deciding that the property is still there and that there is still rent to collect. The idea of “holding out for the long term” is also extremely prevalent especially in Singapore and Hong Kong.

Challenges with Investing in Property

As many have realized by now, the Singapore government is not a “hands-off” government. It lives up well to it image of a nanny state, especially when you compare it countries like the US where free markets reign supreme.

With regards to housing specifically, the Singapore government intervenes heavily time and time again. Housing is the largest asset for most Singapore families, and there are serious political repercussions if property prices rise too fast (making it unaffordable) or fall to much (thereby destroying wealth).

Serious mismanagement of both supply and macro-policy more certainly leads to citizens voting on their feet at ballot boxes. In this regard, there are few issues that Singaporeans care as much as housing and the government is acutely aware of it.

In recent years, the government has introduced successive rounds of cooling measures such as additional stamp duty (ABSD) as well as introducing restrictions on borrowing such as Loan-to-Value Limits as well as TDSR (Total Debt Servicing Ratio) to limit how much investors can borrow.

This has the effect of making investing in property far less attractive than before.