My Oil Stock Adventures

I never realised I had so many oil-related stocks, until nearly every one of them started to tank. That is the problem with a bottom-up approach to stock investing; you might not realise how concentrated you are to a particular industry. The list of my oil-related stocks (prior to the mini-crash in Oct) is: MTQ, ChinaAvOil, PEC, Rotary and CH Offshore. During the mini-crash in Oct, I had picked up CSE Global and averaged down on MTQ, not realising that oil prices were falling steadily. It was only in late Nov when OPEC decided not to cut production did I realised that oil prices were falling so rapidly. As you would have guessed, both CSE Global and MTQ dropped below my buying price. The only consolation I had from these oil-related stocks was Falcon Energy's conditional cash offer for CH Offshore at $0.495, thus giving me a put option on the stock. Hence, despite Keppel Corp and SembCorp crashing through multiple support levels throughout Oct and Nov, I decided to steer clear of these 2 stocks that I had been monitoring for some time.

Having no luck with oil-related stocks, I decided to turn my attention to non-oil-related stocks, hoping to have more luck there. UG Healthcare was having an IPO in early Dec. I usually steer clear of IPOs, for reasons discussed in The Initial Public Offering, but with Riverstone performing so well, I decided to apply for the IPO. Unfortunately, I did not get any shares. Not only that, when the stock started trading, I went in and chased the stock and bought it at $0.295. Furthermore, due to miscommunication with my father, he bought another tranche for me at $0.26. The stock promptly fell to $0.23 by the close of the first week of trading. So, here I was in mid Dec, having lost money on oil-related stocks, broke my rules on not buying IPO stocks and had double exposure to the IPO stock! While it is quite normal to see a stock goes down further after buying it, this series of events was a complete mess! I promptly sold off half of UG Healthcare at a loss to reduce my exposure.

Having no luck with both oil- and non-oil-related stocks, I really should have taken a break from the stock market. However, Keppel Corp kept on tempting me with "everyday low prices". I decided to dig in and review the stocks and my portfolio.

The first thing I did was not to go out and buy Keppel Corp. Rather, it was to shore up the defences in case the stock market goes further south. A few stocks were identified for selling, namely, Boustead (for falling below a trailing stop), GoldenAgri (it was a fringe stock in my portfolio anyway), Midas (earnings have not recovered after 3 years) and LTC (jury is still out on this stock, though). In addition, I had 2 put options in CH Offshore and UE E&C (takeover offer at $1.25). I sold Boustead and GoldenAgri to replenish the cash.

It was not possible to go in and buy Keppel Corp without first analysing where oil prices would be heading. But since I am not an expert and my analysis is likely to be wrong, I shall spare you the details of such incorrect analysis. In essence, I bought Keppel Corp. Between SembMar and SembCorp, I actually find SembMar to be more attractive, but with its Price/Book ratio at 2.2, I decided not to break any more rules. So, I bought SembCorp instead. Finally, my oil-related stocks started to rise after I bought them.

In summary, there will be times like this when nothing seems to go right. Stocks fall after you bought them and rise after you sold them. Rules that you set are broken and past mistakes are repeated. When such times happen, take a break. After you have calmed down, take a hard look at your portfolio and the stocks that you have been monitoring. Rebalance them so that you are comfortable with your portfolio even if the stock market goes further south.

Lastly, I was at a bookstore the other day looking at the book titled "Antifragile". Attached on the cover of the book was a slip of paper that said "Tough times don't last; tough people do".

Wishing all readers a Happy, Prosperous and Healthy 2015. Thanks for staying tuned to this blog throughout the year.

See related blog posts:

• The Missing Link Between Oil Price & O&G Profitability
• My Upstream Oil & Gas Rescue Operations
• My Downstream Oil & Gas Recovery Operations

Minimising the Costs from SRS and CPF Investments

Thanks to owq's and Uncle CreateWealth8888's comments to my previous blog posts on SRS Exit Strategy and Maximising the Benefits from SRS, I had omitted to mention, for reasons discussed below, the costs of investing through the Supplementary Retirement Scheme (SRS). If you invest in shares and unit trusts, the transaction fees charged by agent banks are $2.50 per 1,000 shares/ units, subject to a maximum of $25 per transaction. In addition, there is a maintenance fee of $2 per counter per quarter. Thus, if you hold a diversified stock portfolio of say, 20 stocks, the costs can add up quickly and reduce the tax savings from SRS. The same fees apply to investments made through the CPF Investment Scheme.

Assuming a 20-stock portfolio, an investor who invests once in each of the stocks would incur transaction fees of $50 and quarterly maintenance fees of $40. Total annual cost inclusive of GST would add up to $224.70. In contrast, an investor whose annual income is $30,000 would only save $200 from contributing to his SRS account. The annual cost would more than offset the tax savings from SRS for this investor.

How would the analysis in SRS Exit Strategy change after adjusting for costs? The results are updated below.

Fig. 1: Change in Portfolio Value Due to SRS Assuming 30-Year Investment

Fig. 2: Change in Portfolio Value Due to SRS Assuming 35-Year Investment

Generally, after accounting for costs, the benefits from SRS reduce for all investors. The largest impact is to investors in lower-income groups, as they derive less tax savings from SRS compared to those in higher-income groups.

Are there any ways to reduce the costs from SRS and CPF investments? If you invest in unit trusts, you can reduce the cost by investing through DollarDex or Fundsupermart. They hold the status of Investment Administrator, which is able to consolidate all transactions made at the same time into a single transaction and make a single withdrawal/ deposit with the SRS/ CPF agent bank. So, regardless of the number of unit trusts you buy, the transaction fee is only $2.50. In addition, the quarterly maintenance fee of $2.00 only applies once per quarter regardless of the number of unit trusts you have in your account. Fundsupermart has a good illustration of how the Investment Administrator works in their Frequently Asked Questions. (Note: Fundsupermart collects platform fees on a quarterly basis, which is on top of the transaction and maintenance fees collected by agent banks).

Thus, although I invest my SRS funds in 2 equity funds on a monthly basis using dollar cost averaging strategy, I am able to reduce the transaction fees by investing the full $12,000 into a money market fund once a year. Every month, I will then manually switch $1,000 from the money market fund into the 2 equity funds. The annual transaction fee is thus only $2.50 + GST. This is cheaper than subscribing to a regular savings plan that automatically withdraws money from the SRS account on a monthly basis and incurring transaction fee each time a withdrawal is made.

For my CPF investment account, I reduce the maintenance fee by holding only 1 stock in the account. Thus, the annual maintenance fee is only $20 + GST. As for transactions, I usually wait until I accumulate a minimum investable amount of $5,000 before making the investment.

It is important to minimise expenses in order to achieve good returns from your investments. By understanding how transaction and maintenance fees from SRS/ CPF agent banks are charged, you can work around them and reduce the costs and maximise your returns from your SRS and/or CPF investments.

See related blog posts:

• SRS Exit Strategy
• Maximising the Benefits from SRS
• Why Unit Trust Expense Ratio Matters

Maximising the Benefits from SRS

In last week's blog post on SRS Exit Strategy, I mentioned that the Supplementary Retirement Scheme (SRS) would benefit most investors except for super-investors in lower-income groups who could grow their portfolios by leaps and bounds. This is actually only a high-level analysis. The truth is, everyone, including the super-investors mentioned above, could benefit from SRS at some stage. Before we go into the details, let's recap this chart from the previous blog post, which shows that super-investors in lower-income groups actually benefit less from SRS compared to fellow investors in the same income group who do not invest as well. It is worth investigating the case of the super-investor in the $60,000 income group to understand why this is so and how everybody could maximise the benefits from SRS.

Change in Portfolio Value Due to SRS Assuming 35-Year Investment

The assumptions for the super-investor in this case study are as follow:

Investment Period	35 years
Withdrawal Period	10 years
Annual Income	$60,000
Annual SRS Contribution	$12,000
Annual Rate of Returns	12%

The table below compares the difference in the portfolio value of an annual after-tax investment in a non-SRS account and an annual tax-deferred investment in the SRS account for each year of contribution.

Benefits from SRS for each Year of Contribution

For the non-SRS portfolio, the tax on a $12,000 pre-tax investment is $840 per year. For the 1st year, the after-tax investment of $11,160 compounding at an annual rate of 12% would result in $589,244 by the end of 35 years. In contrast, if this investment is made in a SRS portfolio, the full pre-tax amount would compound to $633,595 by the end of the same period. However, half of this amount is subject to tax. Assuming equal withdrawals over 10 years, the taxable amount each year would be $31,680, attracting an annual tax of $259 or total tax of $2,588 over 10 years. The post-tax portfolio value for this 1st year's contribution would be $631,008, or $41,764 more than the non-SRS portfolio.

Likewise, for the 2nd year, the after-tax investment of $11,160 would compound to $526,110 in the non-SRS portfolio by the end of the 35-year holding period. For the SRS portfolio, the pre-tax portfolio value for the 2nd year's contribution would be $565,710. However, the total value in the SRS portfolio now increases to $1,199,306. This pushes up the total tax payable to $19,476 over the 10-year withdrawal period. Because $2,588 of this tax is due to the 1st year's contribution, the additional tax due to the 2nd year's contribution would be $16,888. The post-tax portfolio value for the 2nd year's contribution would be $548,822, which is still $22,712 more than the non-SRS portfolio. 

As you can see, the benefits from SRS decreases for each year of contribution, until it turns negative for this super-investor by Year 6. The main reason is the value in the SRS portfolio accumulates with each year of contribution, which pushes up the marginal tax rate. If he continues to invest through his SRS portfolio for the full 35-year period, he would gain only $36,469 compared to his non-SRS portfolio. This explains the drop in benefits from SRS compared to fellow investors in the same income group who do not invest as well. On the other hand, if he stops contributing to his SRS account by Year 6, he would have gained $87,710, or $51,241 more. Thus, even a super-investor in lower-income groups would stand to gain from SRS at some stage. The key is knowing when to stop contributing to the SRS account. 

Mathematically, the after-tax value in a non-SRS portfolio for an investment amount is as follow:

[Contribution * (1 - Current Tax Rate)] * (1 + Rate of Return) ^ (No. of Years)

For a SRS portfolio, the after-tax value is as follow:

[Contribution * (1 + Rate of Return) ^ (No. of Years)] * [1 - Future Tax Rate/2]

Thus, investors will benefit from SRS if the current tax rate is more than half of the applicable future tax rate at the time of withdrawal. While current tax rate is known, it is difficult to estimate the applicable future tax rate even if tax rates remain the same. This is because the applicable future tax rate depends on the portfolio value at the time of withdrawal, which is dependent on the contribution amount, investment period and rate of returns. A higher contribution amount, longer investment period and higher rate of returns would all push up the applicable future tax rate, making investment through the SRS account less attractive.  To get the most out of SRS, every investor who invests through SRS would need to assess the benefits from each year of contribution.

While the above analysis can be tedious as it take some guesswork to estimate the rate of returns, there is some certainty for investors in higher-income groups. The highest marginal tax rate is 20% currently. Assuming this highest marginal tax rate remains unchanged at the time of withdrawal, it means that investors who are currently paying marginal tax rates of 10% or more will definitely gain from SRS, regardless of their rate of returns. Currently, this means that those whose taxable income (after SRS contribution) is more than $80,000 will definitely gain from SRS. The higher the marginal tax rate, the larger is the benefits from SRS.

In conclusion, SRS contributions will generally result in benefits for most people. Even super-investors in lower-income groups will stand to gain from SRS at some stage. However, to fully maximise the benefits from SRS, you will need to assess the benefits for each year of contribution.


See related blog posts:

• SRS Exit Strategy
• Minimising the Costs from SRS and CPF Investments
• Deciding How Much Tax You Want to Pay

SRS Exit Strategy

The Supplementary Retirement Scheme (SRS) was started in 2001. I first learnt about it around 2003. Still, it took me a good 3 years before I made my first contribution. The reason? I had not figured out an exit strategy from the SRS scheme. Although SRS contributions are tax-deferrable and only 50% of the withdrawals after the age of 62 would be taxed, there was a lingering concern that I could still end up paying more tax if I could achieve a good rate of returns on the SRS funds. After 8 years of contributing to the SRS account, I finally got around to carry out a sensitivity analysis to determine whether my concerns were valid.

The analysis compares the difference in the portfolio value of an annual tax-deferred investment in the SRS account and an annual after-tax investment in a non-SRS account. The analysis is carried out based on the following assumptions:

Investment Period	30 years
Withdrawal Period	10 years
Annual Income	$30,000 - $120,000
Annual SRS Contribution	$12,000
Annual Rate of Returns	0% - 12%

The tax rates used for the analysis is based on the current tax rates, which can be found at IRAS' website. The analysis further assumes there are no tax deductibles or reliefs for computation of the tax payable.

The results of the analysis is shown in Fig. 1 below.

Fig. 1: Change in Portfolio Value Due to SRS Assuming 30-Year Investment

Based on the chart above, SRS will result in savings for most income groups. The exception is the income group earning an annual income of $30,000 or less. For this income group, an investor who is able to invest his SRS funds at a annual returns of 8% would actually end up with a lower portfolio value if he had contributed to his SRS account. The higher his rate of returns, the lower is his portfolio value. For this person, he is better off paying the tax upfront (i.e. not contribute to his SRS account) and invest his after-tax income.

The reason is because, for this income group, the marginal tax rate is only 2%. The annual tax savings from SRS for a $12,000 contribution would be only $200. But when an investor is able to achieve an annual returns of 12% (let's call him a super-investor), his SRS portfolio at the end of 30 years would be worth a whopping $3.24 million. Spreading the withdrawal evenly over 10 years and only half the withdrawal would be taxed, his taxable income would be $162,000 per year. This puts him in the marginal tax bracket of 17%. He would end up paying $14,320 per year in tax, or a total of $143,200 for 10 years, thereby reducing his SRS portfolio value to $3.10 million. Had he not taken advantage of the SRS scheme, his non-SRS portfolio (based on annual investment of $12,000 minus tax of $200) would be worth $3.19 million, or $89,000 more than his SRS portfolio.

We always hear that it is better to invest early for the magic of compounding to take effect. How would the above analysis change for investors who start making SRS contributions earlier and for longer periods? The results are shown in Fig. 2 below.

Fig. 2: Change in Portfolio Value Due to SRS Assuming 35-Year Investment

 
The effects of a longer SRS contribution and investment period would reap benefits for the higher-income groups but not for the lower-income groups. Although a longer investment period would increase the portfolio value at the end of the investment period, the withdrawal is limited to only 10 years, thus increasing the taxable income per year of withdrawal. For the super-investor in the lower-income group, the net effect is a greater reduction in his after-tax SRS portfolio value. In fact, we start to see similar effects for the super-investor in the $60,000 income group.

In conclusion, SRS contributions will result in tax savings for most people. The only exceptions are super-investors in lower-income groups. Nevertheless, I guess they probably would not mind paying more tax if they could grow their SRS portfolios to $3.10 million! Have you made your SRS contributions for the year already? If not, better hurry, before the year ends.


See related blog posts:

• Maximising the Benefits from SRS
• Minimising the Costs from SRS and CPF Investments
• Deciding How Much Tax You Want to Pay

Fishing for Future Generations

This is a follow-up post from last week's post on Building A Lasting Portfolio for Future Generations. As rightly pointed out by some of the readers, creating and maintaining such a portfolio across generations is not going to be easy. But when you think about it, how many skill sets are easy to transfer to the next generation? You might be the best engineer/ doctor/ lawyer etc. and make lots of money based on your skills, but how easy is it to transfer those skills to your children so that they too are going to be the best engineers/ doctors/ lawyers, etc. That is assuming that they wish to follow your footsteps and become an engineer/ doctor/ lawyer, etc.

The conventional way parents "transfer" skills to their children is to get the best education money can buy and leave behind as much assets as possible for them. The latter is about giving them fish so that they could feed themselves for a couple of years, while the former is about teaching them how to fish so that they could feed themselves for a lifetime. This is a good way, because after all, new technologies and knowledge emerge and old technologies and knowledge become obsolete. Beyond the conventional way mentioned above, can you further enhance the chance that your children (and future generations) will do well in life? 

The key lies in the fish (i.e. the assets) that we leave behind. Besides just being food, can the fish be used as baits to catch even more fish? Some of the descendents will be able to use their acquired fishing skills in their preferred professions to turn those fish into even more fish. Some of the descendents, however, might need some help in this aspect. Possible ways on how to achieve this are discussed in the previous blog post.

While not everybody will be an engineer/ doctor/ lawyer, etc., we are all money managers, for as long as money is used for all transactions. Being trained in money management will go a long way towards safeguarding our financial security and that of future generations.

Post-script

I managed to find Warren Buffett's advice on how his estate (after making all the donations pledged) should be managed. Below is extracted from Berkshire Hathaway's 2013 annual letter to shareholders:

"What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

See related blog posts:

• Building A Lasting Portfolio for Future Generations
• The Passive Portfolio
• How Much Does One's Financial Independence Depend on One's Health?

Building A Lasting Portfolio for Future Generations

It is often said that the earlier you start investing, the more you have for retirement. This is because you have a longer time-span for compounding to take effect. A typical investment life-span is about 30 years, so for a portfolio that can provide 4% real returns (or 7% nominal returns) annually, $1 at the start of 30 years will become $3.24 at the end of 30 years. However, if you can pass down the portfolio intact to your children who can continue to invest for another 30 years, $1 will become $10.52 at the end of 60 years. If they too can pass down the portfolio to their children and grandchildren, the portfolio will continue to compound further.

Although you might have more than 1 child and you wish to split the inheritance evenly between your children, this portfolio may still provide more money for each generation that the preceding one. For example, assuming you have 2 children and each of them will have another 2 children, each child will receive $1.62 and each grandchild will receive $2.63 when the portfolio is passed down to them. While these figures may appear small, these are after accounting for inflation. In nominal terms, each grandchild will receive $14.49.

Before you get too excited, you have to note that this portfolio is meant to be passed down to your children, i.e. it is not meant to support your retirement. If you need to draw down the money for retirement, the portfolio that you can pass down to your children will correspondingly reduce and compound to a smaller value.

How do you build such a portfolio for future generations? Active investment strategies will probably not work. While you might be the best fundamental analyst or technical analyst and make a lot of money from them, how do you ensure that your children and grandchildren are equally good at it? Assuming that you can pass down your analytical skills, how do you teach the mental strength to be greedy when others are fearful and fearful when others are greedy? And this is already assuming that they too are financially inclined and willing to invest the time to pour through financial statements and/or technical charts. So, a portfolio based on active investment strategy will probably not last through the generations.

Among passive investment strategies, there are two -- dollar cost averaging (DCA) and portfolio rebalancing. DCA requires a constant amount of money to be invested at regular intervals in the portfolio. There are 2 issues with this strategy. Firstly, over time, the same amount of money will reduce in value due to inflation. At an inflation rate of 3%, $100 will reduce to $41.20 after 30 years and $16.97 after 60 years. So, progressively, you (and future generations) will need to increase the amount invested over time. To maintain a constant $100 investment at today's value, you (and future generations) will need to increase the amount to $243 after 30 years and $589 after 60 years. The second issue is that DCA is meant to be used to build up the portfolio to a terminal value before you start withdrawing money from it. However, if this portfolio is meant to be passed down to future generations, then there is actually no withdrawal. This means asking future generations to invest an increasing amount of money over time into a "black hole" that they cannot expect to touch in their life-time. This might be too much to ask of them. Although the portfolio could be invested in funds that provide dividends at regular intervals, what they put in in regular investments might be more than what they could get out from dividends. This strategy is probably not sustainable.

The other passive investment strategy -- portfolio rebalancing, requires no further investments to be made. You just need to monitor the asset allocation to ensure that it does not deviate too much from the original allocation. If it does, you just need to sell the assets that have risen in value and reinvest the proceeds into assets that have dropped (relatively) in value. You just need to do this once every quarter or 6 months. If the portfolio is invested in funds that pay dividends at regular intervals, you get an additional source of passive income as well. In essence, this strategy does not require future generations to make any investments, but pays them regularly for maintaining the portfolio with minimal efforts! They are then more likely to maintain the portfolio and pass it down to their children. Also, when they recognise the beauty of this strategy, they could decide to make further investments into the portfolio and enhance it for their children. 

There is still 1 other factor to consider, which is the ability of future generations to make prudent financial decisions. Some of the descendants might be investment experts while others might just squander it away. The vast majority are likely not financially inclined. My current thinking is to split the inheritance so that each has its own portfolio to manage. If one of them were to squander his own portfolio away, there is nothing much we can do, but at least it does not affect the portfolios of others in his generation. For the vast majority who are not financially inclined, the above strategy will work well for them, as it does not require an investment expert to maintain the portfolio. And for the investment experts in future generations, they will be able to grow their portfolios without any help. 

There is a saying that if you give a man a fish, you feed him for a day. But if you teach a man to fish, you feed him for a lifetime. We always strive to earn more and invest prudently so as to leave as much assets as possible for our children so that they can live a better life than us. Yet, are the assets that we pass down to them fish that last a couple of years or fishing instructions that they can benefit for life? Ironically, fish costs money to build up but fishing instructions cost almost nothing but are worth a lot more!

Lastly, please also pass down an instruction to help those in need when your future generations become rich, for their fathers/ grandfathers/ etc. (i.e. us and our fathers), were once poor before.

See related blog posts:

• Fishing for Future Generations
• Experimenting with Investment Strategies
• The Passive Portfolio

You Don't Need To Be Good In Investing To Be Rich

I first read about this chart from Investment Moats. Still, it took me a good couple of months before I realised its implications. In essence, the chart means that you do not need to be good in investing in order to be rich! Pushing the envelop further, it can also mean that everyone could be rich, provided you follow the advice in the chart. The chart is extracted from Vanguard's Principles for Investing Success.

Effects of Savings Growth & Returns

Take a look at the chart above. It plots the value of several portfolios with different savings growth and annual returns. The interesting part of the chart shows that a portfolio with 10% savings growth and 4% returns (dotted red line) could actually outperform a portfolio with 5% savings growth and 8% returns (brown full line)! Before coming into contact with the chart, I thought that the returns rate was the most important factor in growing your wealth. This chart proved me wrong. It also proves that you do not need to be good in investing and achieve double-digit returns in order to be rich. In fact, you do not even need to take on much risk to achieve a 4% return. Several preference shares and bonds could give returns of 4% or more. A list of such preference shares and bonds can be found here. Although Singapore Government Securities (SGS) bonds are currently yielding slightly less than 3%, with interest rates returning to normal in the next couple of years, the yields on these government bonds would also trend higher. The current yields of SGS bonds can be found here.

Are there any catch in this? There is a small one. Assuming a person starts off saving 10% of his monthly starting salary of $3,000, the initial monthly savings is only $300. But at 10% growth rate, the monthly savings would quickly grow to $4,750 by Year 30. It is probably very difficult for anyone to save such a huge amount monthly. However, even if you are unable to follow the 10% savings growth for the entire 30 years, a large amount of savings would have already been accumulated and invested by that time. Assuming the maximum amount that could be set aside every month is $2,500, this ceiling would be reached by Year 24. The value of the portfolio would be $779K at the end of 30 years, compared to $886K if you had followed the 10% savings growth throughout. This value is still higher than the portfolio with 5% savings growth and 8% returns ($744K). The chart below plots the value of the 3 portfolios.

Portfolio Value with Different Savings Growth & Returns

In conclusion, you do not need to be good in investing to be rich! Just like AirAsia's slogon, Everyone Can Be Rich!

See related blog posts:

• All I Want Is To Invest Wisely
• The Lost Art of Bond Investment
• Government Bonds - A Primer