This is Part 3 of the GoBear Personal Finance Series. Do check out the earlier parts by our friends, The Woke Salaryman and SG Budget Babe. The entire series can be found at here.
If you were born at the turn of the 20th century, there is no question that you have it better than your parents when it comes to available options to grow your wealth.
Yet, the plethora of options we have available to us today also mean that we must select what suits us best.
Each of us differs in our risk appetites, our beliefs of the market (yes, it matters), and thus approach the market in a different way. Weighing and evaluating each option given its merits/disadvantages is important for each of us.
This article will set out to plainly explain the various investment options available to the public.
Table of contents
- Exchange traded funds
- What are etfs?
- For whom is this suitable?
- What are robo-advisors?
- Full list of robo-advisors
- Various strategies used
- Do It Yourself Investing
- What is DIY?
- Why DIY?
- Evaluation of the various styles: Value/Growth, Dividends/Income, Quantitative, Day Trading
- Advantages and disadvantages of the various styles
- For whom are the various styles
- Risks in the various styles
- Further educational resources retail investors can pick up to enhance DIY investment skills
#1 – Exchange Traded Funds (ETF)
This is perhaps the most heard of option out there. ETF ETF ETF. It’s almost a bloody slogan. But what is it? What does it do? How is it approached? And what should you know and pay attention to since you’re putting in so much money?
Let’s find out.
What are ETFs?
An exchange-traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index.
Note they can invest in any theme like ESG, or Energy, or Technology, or Biotech. Their broad mandate is often theme/sector (ESG, Energy, Oil) focused, and then focused on tracking the underlying companies. For example a tech ETF would include Facebook, Amazon, Microsoft, Netflix, Alphabet.
Some well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index. ETFs can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types. An exchange-traded fund is a marketable security, meaning it has an associated price that allows it to be easily bought and sold.
The main benefit is diversification across the sector of your choosing, or diversification across the market, and thereby, a reduction of risk. Because an ETF tracks various companies, it reduces unsystematic risk – meaning risk to a single company or a single sector wiping out your investment holdings.
If you’re holding a diversified sector coverage, meaning;
- 20% gold
- 20% bonds
- 20% energy
- 20% technology
- 20% finance
A collapse in any one of the sectors (worst case scenario here) would only wipe out 20% of your portfolio at maximum. Whereas a stock picker who picked the wrong stock would get completely wiped out if he/she didn’t diversify across such positions. Note that ETFs don’t often diversify as above though, normally it distributes across an index at market capitalisation weightage. Meaning the bigger a company, the more the index holds of its shares. DBS Bank, for example, takes up a huge portion of the STI.
ETF Disadvantage #1
The main disadvantage of a traditional ETF can be viewed in two ways:
- 1st, you are not insulated against broad market meltdowns.
- 2nd, you are heavier weighted towards companies with bigger market caps.
On the first, retail investors who fully thrust out their savings and investments into the S&P500 for example might be well advised to understand the term “the lost decade”, which refers to a decade of the S&P500 in which nothing of any value was gained. For ten years, the S&P500 basically didn’t go up at all.
Look at the where the line sits at 2000 and where it sits at 2010. Nothing much occurred and you would only have benefitted if you re-invested your dividends aggressively.
This is one of the problems associated with investing in an ETF, in that you are bound to go where the ship sails once you get on board since you aren’t allowed to steer it.
ETF Disadvantage #2
if you’re willing to put your thinking cap on for a minute rather than listen to the vast echo chamber of finance, you will realise that there are flaws to every strategy. The underlying structure of the ETF is one such angle of attack.
The fundamental idea behind an ETF is simple – if you cannot outperform the returns provided by the market, why not just buy the whole damn market?
But while the idea is sound, the approach is weak. Fundamentally, as spoken above, the bigger a company, the more it dominates the index. Look at this.
This should already be ringing alarm bells. The common idea is to give each company in the index an equal chance.
Or even better.
Giving the biggest weight to the smallest companies, and reverse weighting the companies in the index, such that the smallest companies get the biggest allocations.
That means that for every $1,000 you put into the index, instead of having $500 go the major tech companies as shown above, it will go the tiniest companies in the index because it has been proven that smaller companies outperform bigger companies in terms of absolute returns over time. This is otherwise known as the small-firm effect.
How do you know I’m not full of shit?
Simple. Look at this chart and see the cumulative performance of three people who hold three different portfolios.
- Blue line -> reverse weighted, as described above, small companies get biggest chunk of the pie
- Green line -> equal weighted, everyone gets an equal slice of the pie
- Red line -> normal distribution, biggest companies get biggest slice of the pie
The outperformance of the reverse weighted index vs the S&500 is almost 3% a year annualised. At the end of the period as of 2018 at least (you’ll have to dig recent data up yourself), the cumulative returns from reverse weightage outperformed the S&P500 987.6% vs 506.7%.
Having 9x your money and just 5x your money is a big difference for just a different approach.
It’s therefore worth it to study the markets at least a little instead of brainlessly dumping cash into the ETF.
ETFs: For Whom Are These Products Suitable?
The advantages lie in broad market approach with more diversified risk and the disadvantages can be neutered by simply selecting better structured ETFs. Since the characteristics of the ETFs are broadly diversified and the approach rather simple, this is mostly for those who fall into the category of;
- Want to invest over a long horizon (10-20years)
- Able to sustain periods of drops in value (ie, bear market, 2008-2009 GFC)
- Does not desire to pick stocks or;
- Does not have the confidence to do individual stock selection
Risks of ETF
There are various things to note about risk regarding an etf but for the most part, since this is for beginners, I will endeavor to instead highlight the biggest sticking point. The biggest risk of any ETF is that its often judged by its cover.
ie; It purports to do something that it doesn’t actually do. Which is why I always advise members of the public to carefully screen what the underlying holdings are.
Take a careful look at the holdings of this: “US Vegan Climate ETF”.
In what ways are any of these organisations purported to be behind veganism? None. None of these companies are pure “vegan” supporters. I’m pretty sure Bank of America has at least one meat based customer it supports. The rising wave of investors who clamor to be involved in the market has led marketing to do it usual brand of bullshit with ETFs.
Wrap a nice name on a bunch of securities and sell it to investors who want to feel good about what they are investing in and who don’t really check the fund’s underlying holdings.
Don’t fall for the fad. Always check.
#2 – Robo-Advisors
Robo-advisors are the hot new fad sweeping the fintech industry. Mostly systematic/programmatic/quantitative systems with preset risk levels and asset allocation rules (based on your risk preferences), robo-advisors are the new frontier in the investment business. Because Investopedia has neatly summarised them and has a good slant, i’ll simply repost what they have mentioned. And then I’ll add on my own two cents.
The first robo-advisor, Betterment, launched in 2008 and started taking investor money in 2010, during the height of the Great Recession. Their initial purpose was to rebalance assets within target-date funds as a way for investors to manage passive, buy-and-hold investments through a simple online interface. The technology itself was nothing new. Human wealth managers have been using automated portfolio allocation software since the early 2000s. But until 2008, they were the only ones who could buy the technology, so clients had to employ a financial advisor to benefit from the innovation. Today, most robo-advisors put to use passive indexing strategies that are optimized using some variant of modern portfolio theory (MPT). Some robo-advisors offer optimized portfolios for socially responsible investing (SRI), Hallal investing, or tactical strategies that mimic hedge funds.
The advent of modern robo-advisors has completely changed that narrative by delivering the service straight to consumers. After a decade of development, robo-advisors are now capable of handling much more sophisticated tasks, such as tax-loss harvesting, investment selection, and retirement planning. The industry has experienced explosive growth as a result; client assets managed by robo-advisors hit $60 billion at year-end 2015 and are projected to reach US$2 trillion by 2020 and $7 trillion worldwide by 2025.
Previously, you had to pay a human to help manage all of this for you. But companies quickly realised that if you can script a set of actions onto a bunch of code in terms of portfolio allocation using the Modern Portfolio Theory to help retirees (defensive position) vs new & young investors (aggressive) and with a high degree of success, then you could, in theory, fire all of your financial advisors, save a lot of salaries & commissions in costs, pass on that reduced cost to your consumer, and make buckets of money all at the same time. The downside of course, is that more personalised plans become far harder to implement using a robo, but that can eventually, over time, be overcome with improving layers of design.
Seedly has also compiled an ultimate robo advisor guide which you can find here.
What strategies do Robo-Advisors use?
Technically speaking, no one robo-advisor uses the same strategy. Most robo advisors stick to their own investment methodology. This creates mostly chaos and confusion but is also necessary to distinguish one advisor from the next. Seedly has very helpfully listed the various robo-advisors down and their methodology of investing for their clients. I will simply list some here for you to get a taste, and you can find the rest by clicking on this link.
- Autowealth -> A rule-based investment approach and strategy which places a strong emphasis on diversification across major asset classes, geographical regions, and industries.
- DBS Digiportfolio -> 2 investment portfolios: Global and Asia portfolio. Invest according to different risk profiles.
- Endowus -> Building of Global portfolio via Dimensional Fund Advisors (DFA) & PIMCO funds
- GrabInvest -> TBC
- Kristal.AI -> Curated ETFs, goal-based financial planning and customized portfolios by AI-based advisory
My criticism of robo-advisors stem from the fact that no one person is the same as the next, and while there are many similarities in life goals, attaining those goals often require different steps to be taken.
You can’t put a shoe in a frying pan and expect to make a meal out of it, and as Buffett said, you can’t get a baby by making 9 women pregnant. Speed, defensiveness, aggressiveness, risk appetite, fees, portfolio structures/allocations, investment methodology, are all part and parcel of the individual and should all therefore be derived from the individual.
Unfortunately, my trawling of the web and across the various robo platforms does not indicate any one of them that might perfectly suit my needs. Most people will be underserved, overserved, or somewhat served but never exactly served as they need to be.
The good news for rob-advisors is that most people are willing to see past this individualised issue for the sake of convenience and relatively low fees. And over time, as I’ve mentioned, their capabilities will evolve. Active management robo-advisors are also upcoming but will probably need more time to be proven effective.
Do It Yourself Investing/Active Investing
What is DIY?
DIY investing is the last frontier of investing and is also one of the only active investing frontiers left to be breached by Singaporeans as a whole. On a percentage basis, Singaporeans have just 3.875% of their total assets invested in listed securities.
Putting aside the fun fact, DIY investing is basically stock/asset picking. To be exact, it is the systematic, evidence driven process of individual stocks that the retail investor feels might best outperform the market in the coming years.
There are various reasons behind doing DIY investing. But all of them basically come from one simple mandate.
DIY investors believe that through skill, luck, or some combination of it, they can beat the market’s returns.
Inherently, DIY investors are the gun-toting, wheeling, dealing, sons of bitches that believe in their own ability to analyse, buy, and sell companies, securities or other derivatives in a way that beats the market.
This is not in itself surprising. There’s plenty of information and data that proves it can be done and has been done by various people. I will now go into the various styles.
Evaluation of the various styles: Value/Growth, Dividends/Income
Advantages & Disadvantages of the various styles
- Value -> Buy companies when their share price does not reflect the full value of the company’s assets less all liabilities. You’ll feel a lot of random pain as the market gyrates but when the companies clear up whatever issue they are facing, big gains come quickly. Typical holding period 3 years.
- Growth -> Buy companies massively expanding total sales by volume and margins. This is more rocket ship like. Typical holding period forever.
- Dividends -> Buy companies with secure businesses that pay out huge cash flow which lets you compound your wealth by buying more stocks that pay out more cash flow and on the cycle goes. Typical holding period forever.
- Quantitative -> What the stock market looks like mathematically, its actions, movements, behaviors mapped out mathematically, and then taken advantage of in a systematic fashion. Short holding periods dependent on style. Our quantitative investment course rebalances half its portfolio daily and half its portfolio monthly.
- Day Trading -> Technical trading. I’d classify this as not investing and as a whole other topic.
Value –> Of all of the above, I’m more a value investor. To be exact, I’m more deep value. I look for companies trading under $100-$300 million (where big boys can’t really play) and find companies that are massively undervalued compared to the assets they have and the liabilities they owe. Then I buy them in bulk and hold them for 3 years more or less. Most of the time, they’ll have some sector difficulties. Shipping, uranium, oil, energy, most of these places have been shitty sectors to be invested in for the past decade because of oversupply and easy money and as a consequence, this is where their values have slipped so far down that its become almost comical.
Growth investing –> more for the people who want to ride rocket ships to the top. But, as ever, there’s no guarantee that a company’s competitive edge will not be eroded as they expand. Growing companies also have their own problems. But as Microsoft, Facebook, Netflix, Alphabet and Amazon shareholders can attest to, when these companies take off, they really do kick a lot of ass and boy do you feel really smart as a growth investor.
As a side note, our factor based investing course focuses on Value/Growth at the far ends. We buy deeply undervalued companies and hyper-growth companies. Period. Nothing else. Well, recently we’re buying options because we’re getting really antsy about what’s coming, but that’s for another day.
Dividends -> Mostly, these companies don’t grow much, and they’re not deeply undervalued. What they are is mostly mature, large companies, with a well entrenched business that serves a direct need with repeated business. REITs are a simple example. As a result of their business, they can afford to pay out regular dividends which, if you reinvest over a period of time, will snowball rather well. Chris Ng has taken advantage of this fact to become a millionaire. He’s living proof you don’t always have to buy value/growth stocks.
Quantitative -> This is more for folks who are mathematically inclined. Generally speaking, there’s no complex mathematics here, but the relationship between various asset classes come into play. This video by billionaire ray dalio is instructive.
Are the various styles perfect? Of course not. These are the risks and weaknesses.
There isn’t a free lunch in this world so i’ll take the chance here to identify how you get screwed with any of the investment styles.
Value -> You buy a cheap stock that gets cheap and you’re wrong on the analysis of a problem being fixed. In fact, it doesn’t get fixed over time and the company dies. Your investments head to zero.
Growth -> You pay up for the growth and it never happens. Share price dives off a cliff. You never recover. Next better player please.
Dividends -> That so called mature company starts losing business and therefore income. Dividends trickle off to a stop and the company starts bleeding. Once yields get slashed, prices tend to drop. You can eat the loss or move on.
Quantitative -> Asset allocations are set by volatility levels across multiple asset classes with the hope that correlation never hits 1. If it does as in the GFC and you’re not reacting fast enough, you get crushed anyway. It is for this reason that we monitor daily the portfolio’s behavior. More advanced practitioners can layer in stop losses to trigger and protect downsides even while sleeping.
Further educational resources retail investors can pick up to enhance DIY investment skills
I will list some books retail investors would be best off reading, learning and applying. I can assure you application is much harder than finishing the book. But you will at least have an understanding of what works prior to investing hard earned money.
Once you’ve read the books, you’ll begin to see a pattern emerging. There are statistics in the market on certain companies that have explanatory power on why some investors make money and others don’t.
Also, before I forget.
The lessons in his letters are timeless, and frankly speaking, won’t be gotten from a book. Read it before you invest a single cent and you’ll be far better off for it than without it.
I hope this has been informative for you in opening your eyes to the variety of options available for wealth accumulation. There are quite a few I have deliberately left out in the hopes of keeping this article a readable size.
I highly encourage you to discover and explore the options you have available to you and to at least try each investment vehicle at least for a year or two with small sums.
Like the taste of food, the experiences of investing cannot be earned with your eyes. It can only be experienced with small sums of cash before you’re truly able to tell what kind of person you are, and what kind of risk tolerances you have. Like a contact sport, investing can be fun, challenging, bloody, and downright exhausting at the best of times.
Try it for yourself first. Decide which option later.
This is Part 3 of the GoBear Personal Finance Series. Do check out the earlier parts by our friends, The Woke Salaryman and SG Budget Babe. The entire series can be found at here.
There’s also a Personal Finance Quiz that you can stand to win lucky draw prizes – Apple AirPods and NTUC vouchers! Take the quiz here!