They know how to make their money work for them. But, even the rich make mistakes. Angel investor and entrepreneur Lim Dershing shares the 4 most common investing mistakes that Singaporean millionaires made in 2014.
Words by Lim Der Shing
Updated 15 January 2015
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It is common knowledge that even highly educated high-net-worth individuals – folks with S$1 million in liquid financial assets – with many years of experience make investment mistakes. The key difference is how they plan for and react to these mistakes. Below are four bad calls made in 2014 by people who are supposed to know better and how they could have mitigated the effects.
- Over-allocating to company / country / industry calls by “experts”
In 2014, there were two conventional wisdom calls made and echoed by various economic and stock experts that unexpectedly turned sour. The first concerned energy prices and the second was about China.
At the start of the year, everyone was expecting energy prices to stay high or at least above US$80. However, at the end of December, crude oil prices dropped like a stone, hovering above US$50 per barrel. It doesn’t seem to be getting any better – prices have dipped to below US$50, levels that haven’t been seen since 2009. Energy stocks and countries which depended on energy exports, such as Malaysia, have fallen likewise. See the stock prices of Keppel and other offshore firms.
The other bad call was to underweight China, as the financial system seemed shaky and the economy was slowing down to 7 percent growth. Instead, the Chinese markets have not only rallied but embarked on an incredible tear in the final quarter of 2014. The Shanghai Composite Index rocketed up an incredible 40 percent due to the Shanghai – HK stock connect, the return of retail investors, and an interest rate cut by China’s central bank.
How can one mitigate these bad calls? The key is to recognise that we will always make bad calls. So, we should stick to the strategy of diverse portfolio allocation. What this means is that even if we believe strongly in a particular stock, country or industry, we should always allocate only up to a maximum of 2 to 5 percent (depends on your portfolio size) to it. That way even a 50 percent drop in that investment will mean just a 1 to 2.5 percent drop in your overall portfolio, which can be made up by other allocations. And more often than not, one sector’s loss is another sector’s gain. For example, transport and consumable stocks have done well due to low oil prices.
- Unknowingly taking currency exposure
One call that was quite accurate was to overweight European equities with the idea that Europe is now where the US was back in 2011. Indeed, MSCI Europe has risen about 7.5 percent in 2014. However, some investors did not do their currency homework and converted to Euro to buy equity. The Euro has weakened by some 7.5 percent against SGD in 2014, effectively wiping out all capital gains!
Similarly, some high-net-worth investors have ventured into the Japanese market, correctly betting that the Bank of Japan’s expansion of its quantitative easing programme will boost equity stocks. However, the yen’s fall has wiped out a good portion of gains too.
How can one mitigate this? The key is to always take currency movements into consideration when investing overseas. And if there is no desire to bet on currency at the same time, it is better to hedge either through an option or a simple loan in that domestic currency.
- Not assessing fixed income risk and leveraging
Many private bank clients are guilty of this. They chased ever higher yields on bonds by leveraging up and buying increasingly risky bond issues. I even suspect that they over-allocated their portfolios to such bonds, as these bonds are easily available from private banks and even through priority banking. That means, it is possible for an investor with S$1 million to own a $250K bond. While the 25 percent allocation is fine, the concentration of risk on one counter does not make any sense. If that one counter were to default, a quarter of the investor’s savings will go down the drain on a supposedly safe investment! And if the investor leveraged up to juice his or her returns, he or she will be hit by a double whammy when interest rates rise in 2015.
How can one mitigate this? For allocations into fixed income, buy various bond funds (unless you are able to outright buy a minimum of 20 bonds and up). At the same time, conduct what I like to call “scenario planning” on your leverage if your costs of funds rise to 1.5 percent. And for those who are buying individual bonds, you may want to consider viewing bonds as hold-to-maturity instruments and build a bond ladder around them, instead of trading the bonds away. Aim for a 3.5 to 4.5 percent nett return on these bonds.
- Holding too much cash
I admit that this is highly contentious but for high-net-worth investors, I feel that a fair cash reserve should be between one to two years of expenses. Holding more than that in cash just means your net worth is being eroded by inflation. Cash also drags down overall portfolio performance.
Many investors have done well in equities in 2014, but if equities made up just 10 percent of their investible portfolio while 30 percent was in cash, 30 percent in bonds, 5 percent in gold, and 25 percent in property, then on hindsight, the portfolio probably did less ideally in 2014. Many local investors also keep large cash positions because they don’t want to miss a buying opportunity caused by a crash.
How can one mitigate this? A common solution a few high-net-worth investors use is the bucket concept. Set aside a bucket for expenses for the next one to two years. Then, set aside another bucket for opportunities to come along. This can be large or small depending on your risk profile and investment style. The remainder is your investment portfolio. Then make sure this portfolio is fully allocated.
CORRECTIONS: An earlier version of the article misspelled the author’s name and made an attribution error regarding the Shanghai – HK stock connect scheme.