This is the final part of the trilogy of blog posts on how I set up a passive portfolio. This trilogy was inspired by the desire to set up a portfolio that needs minimal attention. It is also to give an example to some of my friends who are new to investing on how they could invest their money.
Just to recap, in the first post, we discussed that a common rule of thumb for the allocation into the bond component of the portfolio is your age in percentage. For example, if your age is 30, you allocate 30% of your portfolio to bonds and 70% to stocks. We also discussed that the larger the margin allowed for volatility swings in the portfolio allocation before rebalancing takes place, the higher is the portfolio value. In the second post, we discussed that the greater the volatility of the stock and bond components, the higher is the portfolio value. Hence, based on the above research, my planning parameters for the portfolio are as follow:
The bond allocation is actually lower than my actual age. That is because I am an aggressive investor. For less aggregate investors, they can stick to the rule of thumb mentioned above. For conservative investors, they can increase the allocation to bonds by 10% more than the rule of thumb suggests.
Next, on the selection of stocks that make up the stock component, I selected an index fund as literature overwhelmingly shows that the vast majority of investors actually cannot beat the market. There are 2-3 index funds available on unit trust platforms such as FundSuperMart (FSM) and DollarDex, namely, Infinity Global Stock Index, Infinity European Stock Index and Infinity US Stock Index. As the European and US funds are regional-specific, they have higher risk and volatility compared to the Global fund. Although the research above shows that higher volatility will lead to better portfolio value, my preference is for less country-specific risk to adverse events such as the European debt crises. Hence, my selection for the index fund is the Infinity Global Stock Index.
On the selection of bonds that make up the bond component, the research shows that bonds with long maturities and low coupon rates are most volatile and will lead to higher portfolio value. On this basis, the ideal bond would be the 30-year Singapore Government Securities (SGS) bond. Again, I deviated from my research for the following reasons (more excuses really):
- The SGS bond and the index fund are traded on different platforms. E.g. the SGS bond is traded on Singapore Exchange (SGX) or with the banks while the index fund is traded on unit trust platforms. When rebalancing takes place, you will need to transfer money across the platforms. The only platform that deals with both is FSM, but I don't like paying platform fees just for holding the bond/ funds.
- Because they are on different platforms, you will have to compute the current allocation to stocks/ bonds yourself.
- The SGS bond can be traded on either SGX or with the banks. Bank staff seldom deals with SGS trading and you have to educate them every time you trade.
- The SGS bond reduces in maturity over time. Hence, every few years, the bond would have to be sold in exchange for new 30-year bond to maintain the long maturity.
- There is country-specific risk in SGS bonds.
Hence, I turned to FSM (but trade on DollarDex) for a selection of bond funds. A snapshot of the available list of bond funds is shown below.
|Bond Funds Available at FSM|
As mentioned in an earlier post on Why Unit Trust Expense Ratio Matters, expense ratios matter significantly in the overall return of the funds. At an expense ratio of 1% and possible returns from bonds of 5%, that is paying 20% of the expected returns for management of the funds every year.
There are only a handful of bond funds that has expense ratio of around 1% or less. Among these bond funds, I selected the one with the higher risks, taking into consideration the fund size as well. My selection for the bond component is the Schroder ISF Global Corporate Bond SGD Hedged fund. According to the fund description on FSM, it is invested in bonds of governments, government agencies, supra-national and corporate issuers worldwide, with a maximum of 20% held in government bonds. Corporate bonds have higher risks than government bonds, which suits the objective of having a high-volatility bond, while reducing the country-specific risks with worldwide diversification.
Hence, my eventual portfolio is:
- 70% in Infinity Global Stock Index
- 30% in Schroder ISF Global Corporate Bond SGD Hedged fund
- Portfolio is rebalanced whenever the allocation exceeds the above allocation by 8%.
In the final analysis, research can tell you one thing, but the portfolio that you construct must be consistent with what you believe in, your risk appetite and your judgment of how financial markets will perform in future. You must be comfortable with the portfolio so that you can go through thick and thin with it. Only then can you reap the rewards of investing with the portfolio.
See related blog posts: