Sunday, 28 December 2014

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.

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Sunday, 21 December 2014

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.

Monday, 15 December 2014

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 Period35 years
Withdrawal Period10 years
Annual Income$60,000
Annual SRS Contribution$12,000
Annual Rate of Returns12%

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.

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Sunday, 7 December 2014

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.

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Sunday, 30 November 2014

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.


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."

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Sunday, 23 November 2014

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.

Sunday, 16 November 2014

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!

Wednesday, 12 November 2014

Be Cautious While Being Greedy

The roller-coaster ride of the stock market this past month has brought back memories of the events 6 years ago. Whenever I write about the Global Financial Crisis (GFC), it invariably comes with a tinge of pride. After all, it was a major crash and we managed to recover from it. However, was victory assured right from the beginning, that all we had to do was, in the words of Warren Buffett, to be greedy when others were fearful, or was it a narrow victory snatched from the jaws of defeat? In other words, was buying at the depth of GFC a wise decision or was it a reckless decision that turned out to be lucky? Does this question still matter, since the outcome was positive? My opinion is that it matters, because Lady Luck would not always stand on your side. Although Man proposes, Heaven disposes, we still need to make wise decisions.  

What prompted me to pull the trigger at the depth of GFC in Oct 2008? It was a combination of game plan, indicators, news and history. Info on my game plan and indicators that I consulted are described in Have a Plan, Knowing When Others Are Fearful and Structured Warrant Statistics. The news that caught my attention was the European governments coming together to work out a plan to save the economy (see Declaration on Concerted European Action Plan). As you know, Europeans usually do not readily agree with each other, but the fact that they were ready to put aside their differences and work together signalled that we could begin to see light at the end of the tunnel. And a review of the history of the stock market shows that in the long run, stock market crashes are usually temporary bumps in the long march upwards.

There are, however, 2 problems with history. Firstly, history is written by those who survive the event or those who just watch the event from the sidelines. History is usually not written by those who do not survive the event. And if they were to tell their version of history, the history that they tell could be very different from the history that we know. I once had a colleague who refused to touch stocks again and never spoke about his experience. I guessed he lost heavily in the stock market before. His history will never be known. But could his history not befall on us? 

The second problem with history is that you do not really know which history is playing out when you are in the thick of the action. Was it going to be the history of the Asian Financial Crisis, when stocks rebounded about 15 months after the start of the event, or was it going to be the history of the Great Depression, when stocks found their bottom only 3 long years after the onset? If it was the latter, it was going to be a long road down.

Overall, do I think the decision to invest during the depth of GFC was a wise decision or a reckless decision that just turned out to be lucky? In truth, I believe I have quite seriously underestimated the potential consequences of GFC due to a lack of knowledge of how the economy and the financial world works even till today. So, it certainly wasn't a wise decision that considered all risks. It was at best a decision that was calculated, but had not understood all risks. 

It is particularly instructive to understand what Warren Buffett, the owner of the famous quote "Be fearful when others are greedy and greedy when others are fearful" did during the same period. True to his words, he invested a total of US$20.2 billion in some fixed-income securities with equity participation between Sep 2008 and Apr 2009 (see Buffett's Crisis-Lending Haul Reaches $10 Billion). These securities have both downside protection as well as upside potential. If the stock market dropped further, he could count on receiving dividends from the securities. Conversely, if the stock market recovered, he could convert some of the warrants into equities and profit from the rise in equity prices. His largest equity investment during that period, a US$34 billion acquisition of a railroad, which he described as an "all-in wager on the economic future of the United States", occurred in Nov 2009, when events were more stable (compare Berkshire Hathaway's equity holdings in 2007, 2008 and 2009 in their annual shareholder letters).

What can we learn from this greatest investor in the world? It is that it is not good enough just to be greedy when others are fearful. We also need to be cautious when being greedy. Sometimes, it might just be better to wait until the coast is clearer before making your moves.

In conclusion, while being greedy when others are fearful could help one to make money during "normal" stock market crashes, being cautious regardless of whether others are fearful could save one's skin in an extraordinary stock market crash. Hence, the main reason why I could still be blogging is because the crash did not turn out to be a Great Depression type of crash. For this, we have Ben Benanke, the former Federal Reserves chairman, to thank for. Thanks for saving the whole world from another Great Depression.

Sunday, 2 November 2014

Knowing When Others Are Fearful

The correction in this past month has been fairly amazing. Stocks had been falling faster than I could juggle and yet, the Straits Times Index actually ended the month basically unchanged. The Dow Jones Industrial Average (DJIA) even closed at a record high, as if no correction had happened. Whenever the stock market goes on a nosedive, I would be reminded to check an indicator, which is the Chicago Board Options Exchange Market Volatility Index, or VIX in short. VIX is used by some investors as a fear indicator, spiking up whenever there is great volatility in the market and staying low when the market is peaceful. As Warren Buffett said, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”. It is useful to have an indicator to know when others are fearful.

Relationship between VIX and DJIA

The chart above shows the relationship between VIX and DJIA. As you can see from the chart, whenever VIX spikes up, a bottom tends to form around these spikes. However, note that this bottom might just be a temporary one, as the market might bounce back up before declining further. Also during the Global Financial Crisis (GFC), VIX actually hit a high of 81 in Nov 2008 but the market continued to crash through before finally bottoming out in Mar 2009. If you had entered the market at the first instance VIX hit 40 and above on 29 Sep 2008, where DJIA was at 10,365 points, you would be nursing a loss of 37% when the DJIA finally bottomed out at 6,547 points on 9 Mar 2009. So, is it still a useful indicator for timing your market entry?

Firstly, I don't rely solely on this indicator to determine my entry point. In times of great market stress, gut feel invariably plays a big part despite all the game plans and indicators. You need to be really comfortable and mentally prepared to catch and hold a falling knife that shows no sign of stopping. It is no use buying and then selling out a few days later at lower prices because of rapidly mounting losses. Secondly, VIX itself can be very volatile whenever there is great volatility in the market. One day, it could be 35 while the next day, it could spike up to 47, before falling back to 39 the following day. So, VIX on individual days might not be very reliable. But if VIX continues to stay consistently high for several weeks, then it shows there is a lot of fear in the market. The longer the panic selling continues, the closer we are to the bottom. Thirdly, even though VIX is not useful in predicting where the bottom is, I use it to gauge roughly when the bottom is. Using the GFC example above, while you would be nursing a heavy loss of 37% if you had entered the market at the first instance VIX hit 40 and above, you would miss the bottom by a little over 5 months, which to me, is actually not that bad. And if you had waited a little longer to see if VIX had stayed consistently high, you would be even closer to the bottom and entered the market at an even lower entry point. Nobody can predict where the bottom is with certainty. I would be sufficiently satisfied if it could gauge when the bottom is with a error margin of a few months.

In conclusion, VIX can be a useful indicator to know when others are fearful, but understand its limitations and ultimately, you must be really comfortable and fully prepared to accept losses which could mount rapidly if you choose to catch the falling knife. It is also important to note that it helps a lot if you have sufficient cash reserves to cushion the fall. And it is also not necessary to catch the falling knife all at one go. It is normal to get hurt from it, but make sure the wounds are not fatal.

Sunday, 26 October 2014

Experimenting with Investment Strategies

When I first started investing my Supplementary Retirement Scheme (SRS) funds 7 years ago, I wondered how should I invest the money. Should I invest in the same way as my cash account, i.e. adopting market timing and buying individual stocks, or should I keep it as a cash reserve to be used during severe market crashes like my CPF funds? If I invest like my cash account, I wondered what if my investment strategy had been wrong all this while? Would I then still have sufficient funds to retire? Since the SRS account is small compared to my cash account, I decided to invest it in a different way from my cash account, as a form of hedging in case my investment strategy turns out to be wrong. It also serves as a test lab to try out different investment strategies. After 7 years of experimenting, I think it is time to conclude some of the lessons learnt from these investment experiments. 

Active Investing vs Passive Investing

The first major difference between my cash and SRS accounts is that the former adopts active investing while the latter adopts passive investing. In active investing, you have to do everything by yourself, from setting up a valuation model, analysing hundreds of stocks based on the model, updating the data in the model based on the latest financial statements, deciding what stocks to buy and when to buy them, monitoring the stocks in your portfolio and deciding whether to buy some more or to sell them off. A lot of time is required in this approach. In passive investing, things are a lot simpler. You just need to decide which stocks or unit trusts you believe will appreciate in the long term. Once you have decided that, you just need to invest a constant amount of money in that particular stocks or unit trusts on a regular basis, regardless of whether the markets are going up or down. Of course, you do need to review these stocks and units trusts occasionally, to make sure that they do not stray off-course from your investment objectives and criteria. However, the time spent in passive investing is a lot less compared to active investing.

From personal experience, both active and passive investing can be profitable. Passive investing has achieved an annualised return ranging from 3.11% to 7.04%, depending on the unit trusts bought. Coincidently and very importantly, this is also the annualised return for one market cycle (peak-to-peak), as the unit trust prices have roughly returned to where they originally were 7 years ago.  You may wish to read Review of My SRS Investments for more info. Active investing, on the other hand, has achieved a few more percentage points in returns compared to passive investing, based on rough calculations. It should be highlighted that it is difficult to determine the exact investment returns for my cash account as the investing and non-investing cashflows are not segregated, similar to my CPF account which has monthly contributions coming in and housing loan repayments going out in addition to investing cashflows.

Is the extra few percentage points in returns worth the huge amount of time spent in analysing stocks? From a time-value of money perspective, the extra few percentage points will translate to fairly large differences in wealth when compounded over many years. However, from a lifestyle perspective, time spent on analysing stocks means that you have less time for other things in life. Furthermore, do you really need the extra wealth from the few percentage points in returns to retire or to pass down to the next generation? I guess the choice between active and passive investing boils down to personal preference, whether you like the bolts-and-nuts of investing like a personal hobby or you prefer to spend the time on other more important things in life.

Individual Stocks vs Indices

For the cash account, individual stocks are bought and sold. Some stocks can turn out to be multi-baggers that multiply your investment many times over while others can turn out to be salted fishes that wipe out your investment. You can refer to How to Get a Multi-Bagger? and The Salted Fishes for the list of multi-baggers and salted fishes that I have accumulated in the past 16 years of investing with my own money. Generally, a lot of emotions are involved with individual stocks, with joy for multi-baggers and despair for salted fishes. Even when your stock is a multi-bagger, you are constantly in a struggle over whether to continue holding on to it or sell it off before it declines. With unit trusts, however, the emotions are a lot less as unit trusts are less volatile than stocks. The emotions involved can have an impact on whether you can be a long-term investor and consequently, whether you can achieve the returns stocks can potentially provide in the long run. You may wish to read Different Mentality in Stock and Unit Trust Investing for more info.

Because the price of individual stocks can go down to zero, I usually have a limit on the amount of investment in each individual stock. Furthermore, due to privatisation over the past few years, there are not many stocks on the Singapore Exchange that meet my investment criteria. This has resulted in a limit on the amount of money that could be invested in stocks. In contrast, the price of index funds do not go down to zero and hence, there is no limit on the amount of investment. Even though index funds could lose half their value in a severe market crash, historical evidence shows that they usually recover, so there is nothing much to worry about for long-term investors.

Index Funds vs Lifecycle Funds

Within the SRS account, I also split the funds into 2 and invested in equal portion in an index fund and a lifecycle fund. The benefit of a lifecycle fund is that the asset allocation will gradually change from aggressive to conservative over time. This saves an investor the need to regularly and consciously adjust his asset allocation as he ages and is less able to take risk. However, my experience with lifecycle funds is that the asset allocation may not fit the investment objectives of all investors who invest in the same fund. Furthermore, the asset allocation may change from the initial asset allocation model in unexpected ways over time. You may wish to read Experience with Lifecycle Unit Trusts for more info.


When I started the investment experiments with my SRS account 7 years ago, I never expected to learn so much from it. These lessons have come in useful even for my cash account. Also, you do not always need to choose between active and passive investing, or between individual stocks and indices. They can be complementary to each other. For Singapore stocks, I will continue to adopt active investing, but for overseas stocks, I will be adopting passive investing to save the time required to analyse overseas stocks. Similarly, I will invest in index funds whenever there are limited opportunities in individual stocks to maintain an optimal exposure to stocks. I will continue to experiment with investment strategies using my SRS funds. The next experiment will be to compare between a global stock index and a US stock index.

See relate blog posts:

Sunday, 19 October 2014

Not All Market Indices Are Equal

One of the most popular and time-tested investment strategies is to invest passively in an index fund. I too have adopted this strategy for my Supplementary Retirement Scheme (SRS) account. However, not all markets are equal. If you pick a market index that is performing well, you are well on your way to financial independence. Conversely, if you pick a market index that is underperforming, you will take a longer time to reach there. The chart below shows the performance of 5 more familar stock market indices, namely, Singapore's Straits Times Index (STI), US' Dow Jones Industrial Average (DJIA), UK's FTSE 100, Hong Kong's Hang Seng Index (HSI) and Japan's Nikkei 225.

Performance of Different Market Indices

From the chart above, if you had invested $10,000 in each of the 5 market indices at the start of 1988, the investment would have grown to $95,169 for HSI, $87,033 for DJIA, $36,982 for FTSE100, $36,052 for STI and only $6,847 for Nikkei 225 as at end Sep 2014. These figures represent a compounded annual growth rate of 8.8%, 8.5%, 5.0%, 4.9% and -1.4% respectively, excluding dividends. Thus, not all market indices are the same and it is important to select the right market index for your passive investment strategy.

For unit trust investments, there are 3 indices to choose from, namely, LionGlobal's Infinity Global Stock Index, US 500 Stock Index and European Stock Index. Their performance for the past 10 years are shown in the table below.

Performance of LionGlobal Global/ US/ European Stock Index Funds

For all the holding periods, the best performer is the US Stock Index, followed by the Global Stock Index and the European Stock Index. This is not surprising, given that the US economy has shown signs of recovery while the European economies are still mired in recession.

As mentioned in my previous blog posts, I will be switching from an underperforming unit trust to an index fund in my SRS account. Since I already have the Global Stock Index fund, the target of my switch will be the US Stock Index fund, notwithstanding the fact that DJIA might have peaked and could be going downhill from now on. You may wish to read Possibly The Worst Time to Invest on why I am not worried about a bear market for my SRS investments.

Will I be committing the mistake of chasing the hottest index only to see it underperform its peers in the foreseeable future? It's probable, but 26 years of market history could not be wrong. I still remember around 1995 when DJIA was about 4,200 points, I thought it was dangerously high and might crash like it did in 1987. In late 1996, when DJIA was around 6,500 points, the former Federal Reserves Chairman Alan Greenspan first used the words "irrational exuberance" to describe the US stock market. Yet today, the DJIA is around 16,400 points! And despite the rise of China in the past decade, it has been the US companies that have been the most innovative, introducing us to smartphones and tablets, social media, e-commerce, etc. If there is the next game-changing innovation, it will probably be coming from US. Even Warren Buffett has kept faith with the US "Old Economy" when he bought a railroad in late 2009 for US$44 billion including debt. He personally described the transaction as "an all-in wager on the economic future of the United States". You can read this article on whether the acquisition has been a good one after 4 years. Despite all the talk about the China economy replacing the US economy as the largest one in the world in the next few years, there is something resilient about the US economy that I have missed. So, while the switch to the LionGlobal US 500 Stock Index fund is not an all-in wager on the US economy, I too would not want to miss the train.

See related blog posts:

Sunday, 12 October 2014

Review of My SRS Investments

I have been investing my Supplementary Retirement Scheme (SRS) funds in unit trusts for the past 7 years. Yet, it is amazing that I have never reviewed how my SRS investments have been performing on an annualised basis. I do not know for sure whether the returns have beaten the inflation rate, the CPF Ordinary Account rate or the Special Account rate.

Today, I have finally carried out a review of my SRS investments. They have returned 3.8% on an annualised basis since I first made my initial contribution to the SRS account in Nov 2006. A breakdown of the returns from the various unit trusts I have invested in are as follow.

Fund Allocation % Change % Return
LionGlobal Infinity Global Stock Index 38% 0.67% 7.04%
UOBAM GrowthPath 2040 38% 0.40% 3.11%
Nikko AM Shenton Short Term Bond 15% 2.23% 1.98%
Phillip SGD Money Market Fund 8% 0.51% 0.50%
Cash 1%

Total 100%

The 2 main unit trusts are LionGlobal Infinity Global Stock Index and UOBAM GrowthPath 2040. Investments in them are made on a monthly basis using the Dollar Cost Averaging methodology. The Phillip SGD Money Market Fund is used to hold the cash required for the monthly investments into the 2 main unit trusts. The Nikko AM Shenton Short Term Bond Fund is used as a parking facility for excess cash beyond those required for the monthly investments.

The % return in the table above shows the actual annualised return obtained from the unit trusts. The % change shows the annualised change in the price of the unit trust from the time I started investing my SRS funds in Nov 2007 till now. With the exception of Nikko AM Shenton Short Term Bond Fund, most of the unit trusts have not changed much, as shown by the figure below.

Performance of Unit Trusts Since Initial Investment

In fact, both LionGlobal Infinity Global Stock Index and UOBAM GrowthPath 2040 have just recovered to their original prices in Nov 2007. However, through regular investing with Dollar Cost Averaging, the unit trusts have returned 7.0% and 3.1% on an annualised basis respectively. This proves that Dollar Cost Averaging works. In fact, in an earlier blog post, I concluded that Dollar Cost Averaging works best with volatile stocks and unit trusts.

The LionGlobal Infinity Global Stock Index has performed to expectation for a stock index, especially considering the fact that it underwent a severe correction during the Global Financial Crisis. However, the UOBAM GrowthPath 2040 has disappointed for a balanced fund. One of the main reasons for the underperformance is due to the fund manager reducing the allocation to stocks to below that assigned by the original asset allocation model for whatever strategic or tactical reasons. You may wish to read Experience with Lifecycle Unit Trusts for more info. I will probably be selling this fund and switching to an index fund, to be consistent with my risk preference.

As for the other 2 unit trusts, the Nikko AM Shenton Short Term Bond Fund has returned 2.0% on an annualised basis, which is within expectation for a bond fund, while the Phillip SGD Money Market Fund has returned 0.5%, which is also within expectation for a money market fund. The key objective of these 2 unit trusts is to preserve the capital required for monthly investments into the 2 main unit trusts, which they have done reasonably well. I will be keeping these 2 unit trusts as a result.

Finally, in my previous blog post, I mentioned that letting unit trust investments run on auto-pilot can have both good and bad effects. The good thing is that investors are able to ignore all the noise and invest for the long run, thus allowing the magic of compounding to happen. The bad thing is that some unit trusts might fly off-course if not monitored regularly. I believe a review on an annual basis should be sufficient to achieve the good results and avoid the bad consequences of unit trust investing on auto-pilot mode.

See related blog posts:

Sunday, 5 October 2014

Different Mentality in Stock and Unit Trust Investing

I have investments in both stocks and unit trusts.  However, the investing mentality in both can be quite different. These different mentalities can both be a boon and a bane for successful investing in them.

Before I go into the details, I should mention that I generally adopt a market-timing strategy (for when to buy and sell) and value investing (for what to buy) for my stock investments. Please see Have A Plan for more details. However, for my unit trust investments, I adopt a Dollar Cost Averaging strategy with monthly investments into index and balanced funds. The differences in investment strategies explain some of the differences in the investing mentality in both types of investment.

Market Price

For stocks, as we know, they can be quite volatile. You will never know for sure whether they will go up or come down. When a stock that you own has gone up by quite a bit, you start to worry whether it might come down again. You then wonder whether you should sell it off. You have heard about letting the price runs, but you have also seen and experienced for yourself how some stocks came back down in price after a run-up. This struggle happens regularly as the stock continues its climb, and is especially strong when the price starts to correct. Sometimes, you decide to sell, only to see it resumes its climb upwards. Other times, you decide to hold, only to see it starts to descend. The jittery mentality of stock investments leads many investors to be short-term investors, influenced more by the stock price than the business fundamentals of the company. It is thus difficult for most investors to achieve multi-baggers in their portfolios, which requires long-term investing in good companies.   

In contrast, for unit trusts, when they reach new highs, you hope that they would go higher, without any worry that they might have peaked and are about to decline. Even when the prices correct, you accept that this is part and parcel of investment and are prepared to hold them through the price correction. This steadfast mentality of unit trust investments allows investors to invest for the long run, thus enabling the magic of compounding to happen. 


There is always a lot of real-time information about stocks, including company announcements, stock analyst recommendations, kopitiam talks and even rumours. Investors readily take in such information, analysing them thoroughly to estimate the impact to the stock price. The vast amount of real-time information allows investors to constantly evaluate their investments and make the necessary buy and sell decisions to improve the performance of their portfolios. 

In contrast, for unit trusts, there is generally not much real-time information, except for economic and industry news that impact both stocks and unit trusts alike. Information about the performance of unit trusts are published by fund managers on a monthly basis (factsheet) and 6-month basis (performance report). Yet, seldom anyone reads these factsheets and reports. I understand there are investors who regularly switch between unit trusts, discarding the laggards in their portfolios in exchange for the top performing funds in the performance tables. For me, I generally stick to the same unit trusts and let them run on auto-pilot, not realising that the underlying investment strategies of the unit trust could have changed, until the performance of the unit trust starts to deviate from expectations. This is the reason why I had stuck with an under-performing unit trust for 2 years, as mentioned in Experience with Lifecycle Unit Trusts


There are both good and bad traits in the investing mentality in stocks and unit trusts. If we are conscious about the bad traits of the respective investing mentality, we can avoid them and improve the performance of our investments.

See related blog posts:

Sunday, 28 September 2014

Experience with Lifecycle Unit Trusts

When I started investing my Supplementary Retirement Scheme (SRS) funds 7 years ago, it was with several experiments in mind. Firstly, the SRS account adopts a monthly Dollar Cost Averaging investment methodology, as opposed to market-timing for my cash account. Secondly, the SRS funds were invested in an index fund and a balanced fund, as opposed to individual stock selection for the cash account. Thirdly, the monthly investments were split between an index fund and a lifecycle fund, to understand whether lifecycle funds could serve the needs of an investor throughout his lifetime.  

What are lifecycle funds? These are funds whose asset allocations change from aggressive to conservative as time progresses. Using the fund that I bought (UOB GrowthPath (GP) 2040) as an example, the allocation to equities will reduce from an initial 83% (in 2002) to an eventual 20% by 2040. This saves the need for an investor to regularly and consciously adjust his asset allocation as he ages and is less able to take risks. Besides UOB GP2040, there are several other lifecycle funds in this family, namely, GPToday, GP2020 and GP2030. The timeline indicates the year when investors plan to liquidate and withdraw money from the fund. When the timeline is reached, the particular GP fund will be terminated and converted to the GPToday fund, which has an asset allocation of 20% stocks and 80% bonds. The figure below shows the current asset allocation of the various GP funds.

Figure 1: Current Stock Allocation of UOB GP Funds

So, what has been my experience with the UOB GP2040 lifecycle fund? Besides UOB GP2040, I also have invested an equal amount of money in an index fund, the LionGlobal Infinity Global Stock Index Fund, which provides a comparison with UOB GP2040. As you can see from the figure below, UOB GP2040 (blue line) has underperformed the index fund (green line) by some margin, which prompted a review of my unit trust portfolio after 7 years. While some level of underperformance is to be expected as UOB GP2040 does not allocate 100% of its investments to stocks, the level of underperformance have been too much for my liking.

Figure 2: Relative Performance of Index Fund & Life-Cycle Fund

What caused the underperformance of UOB GP2040 compared to the index fund? While part of the reason is due to US stock prices reaching new highs currently, another part of the reason is due to changes to its initial asset allocation. The figure below shows the initial and current asset allocation of the various UOB GP funds.

Figure 3: Initial & Current Asset Allocation of UOB GP Funds

From an initial 83% stock allocation at the time of its inception in 2002, the current stock allocation for UOB GP2040 has fallen to 59% only. Part of it is due to the passage of time as explained earlier. However, another part of the reason is due to the fund manager changing the asset allocation model for whatever strategic or tactical reasons. By right, the asset allocation for GP2040 today should be similar to that of GP2030 10 years ago, since they have the same investment horizon. However, the current stock allocation for GP2040 is even lower than that for GP2030 in 2002, which was around 74%. Thus, the fund manager has moved approximately another 13% from equities into bonds when compared to the initial asset allocation model. Being an aggressive investor, I would have preferred the initial asset allocation model.

What are the lessons to be learnt from this experience? Firstly, the asset allocation of lifecycle funds do not fit all investors who invest in the same fund. Some like myself prefer a more aggressive allocation while others may prefer a more conservative allocation. Secondly, the actual asset allocation may change from the initial asset allocation model. Thus, while lifecycle funds save investors the trouble of having to adjust his asset allocation regularly, they should not be left to run on auto-pilot. There still needs to be some regular monitoring to ensure that the current asset allocation meets the investor's objectives. 

Considering that the current asset allocation of UOB GP2040 no longer meets my objectives, I will probably be selling this fund and switching to an index fund. Despite not being able to accompany me all the way till 2040, investing in this lifecycle fund has allowed me to understand more about lifecycle funds.

Sunday, 21 September 2014

The Value of An Education in Investing

Last week, I blogged about the value of a Chartered Financial Analyst (CFA) education to an investor and concluded that while it is useful in providing a basic grounding on the various investment concepts and methods, it does not guide an investor on what he should look out for in investing. See The Value of a CFA Education for more info. Does it mean that investors should not pursue an education in investing? On the contrary, education is important to achieving success in investing.

I have been exposed to the stock market for 28 years and been investing with my own money for the last 16 years. Prior to 2001, my investments were going nowhere, with as many misses as hits. It was not until when I picked up my first investment book titled "Buffettology" did my investments began to show some progress. You may wish to read Investing Is A Life-Long Learning Journey for more info.

The book triggered my thirst for investment knowledge. I became a regular visitor to the investment section of the National Library, reading investment books ranging from time-tested ones like "The Intelligent Investor" to more contemporary ones carrying fascinating titles like "Dow 40,000", "Dow 100,000", etc.

Among the ones that I found useful, I bought them after reading them in the National Library, to serve as an reference in future. Some of the more important ones are desribed as follow.

Buffettology (by Mary Buffett & David Clark) - This book was written by the former daughter-in-law of Warren Buffett and describes the methods Warren Buffett used to analyse stocks. The book describes the mathematical steps involved in estimating the rate of return of a stock and is fairly dry. Nevertheless, it is an important book for me as the methods in the book became the model that I use to analyse stocks to this date. It is also the book that sets me on my path to an education in investing.

Stocks for the Long Run (by Jeremy Siegel) - This book discusses that in the long run, stock investments beat all the other asset classes, notwithstanding the fact that stock market crashes happen every now and then. It also describes the various effects such as calendar effects, small-firm effects, etc. Whenever there is a stock market crash, I would turn to this book to remind myself that in the long run, my investments would turn out well, despite the heavy paper losses sustained at that time.

Common Stocks and Uncommon Profits (by Philip A. Fisher) - Warren Buffett initially started out as a pure value investor, having learnt his trade from Benjamin Graham, the father of value investing. However, over time, he has introduced a growth element to the stocks he purchases. The influence for this change is Philip Fisher and his book. This book discusses that some companies are so good that there is often no good reasons to sell them at all. The book goes on to describe the various ways of identifying such companies. If Warren Buffett could achieve such spectacular returns with his value-cum-growth approach, then there must be something valuable with this approach.

Security Analysis (by Banjamin Graham & David Dodd) - This book is known as the Bible of value investing and is written by none other than Benjamin Graham. It was written in 1934, during the Great Depression period in US. It describes the ways to value stocks, bonds, preference shares and warrants. You can find an application of its valuation method for bonds and preference shares in The Lost Art of Bond Investment. Despite reading it twice, I still have not grasped the essence of the book, probably because the investing conditions then and now are different. For example, it could be discerned from reading the book that the accounting and disclosure standards are different from today's and hence, the book spends a fair amount of time on the interpretation and adjustment of income and balance sheet items. The basis of valuation is also quite different then, when book value takes on a greater importance compared to today.

The above are just some of the books that I found useful and bought for future reference. There are a lot more books that are useful which I never mentioned, such as "The Intelligent Investor" by Benjamin Graham. Generally, the value of these investment books lies in the fact that they contain practical wisdom from market practitioners who, through past experience, have figured out what works for them. By understanding and following their approaches, we are able to shorten our learning curve and start making money sooner from our investments. After all, with a stock market cycle averaging about 7 years, how many market cycles do we have in our lifetime learning and making money from investments?

Education is important to an investor. Without education, investors can only buy and sell on gut feel and/or follow the crowd. As an analogy, if you were to go to battle, would you select a general that has fought many battles, a general who has studied the art of war, or a general who is knowledgeable in both?

Sunday, 14 September 2014

The Value of a CFA Education

I took a course in Masters in Applied Finance and sat for the Chartered Financial Analyst (CFA) examinations in 2004 - 2006. The purpose of studying and sitting for the CFA exams was to understand the various economics, accounting and investment concepts so as to be a better investor. Hence, the topic of this blog post applies to an investor rather than a person working in the financial industry.

The CFA programme covers very wide topics, as follows:
  • Ethical and Professional Standards
  • Quantitative Analysis
  • Economics
  • Financial Statement Analysis
  • Corporate Finance
  • Portfolio Management
  • Equity Analysis
  • Fixed Income Analysis
  • Derivatives
  • Alternative Assets
  • Portfolio Performance Measurement & Reporting
  • Risk Management

Note that there have been some changes to the curriculum since I sat for the exams. You can find the latest curriculum at CFA Program Study Sessions.

Has the programme been useful to an investor who starts from scratch and has no formal education in investing previously? I describe some of the more relevant topics to investors and their usefuln below.

Financial Statement Analysis (FSA) is by far the most important topic as investors need to read financial statements regularly to understand how the companies are doing. FSA teaches how to understand the various items in the financial statements and the various accounting methods. For example, inventory could be recorded as first-in-first-out, last-in-first-out, or weighted-averaged. The different accounting methods will lead to different values in the balance sheet depending on whether prices are rising or falling. Adjustments will therefore need to be made when comparing companies adopting different inventory accounting methods. Also covered in FSA is how to identify red flags where there could be accounting irregularities. However, although providing the basic grounding necessary for understanding companies, FSA does not discuss what are the important items that investors should look out for when prospecting for a company, such as having low debt, high free cash flow, etc.

Equity Analysis teaches the various valuation methods that you can use to determine the intrinsic value of a stock, such as Discounted Dividend Valuation, Free Cashflow Valuation, Market-Based Valuation (e.g. Price/Earnings, Price/Book multiples, etc.) and Residual Income Valuation. However, it does not advise what kind of input parameters (e.g. dividend growth rate, rate of discount for Discounted Dividend Valuation) you should use for each stock analysis. You need to assume the input parameters and hope that they turn out to be correct. 

Portfolio Management teaches about the Modern Portfolio Theory, which is based on that fact that when 2 risky assets are put together in a portfolio, the combined risk (volatility) is less than that of the individual risky assets. It also discusses the Efficient Market Hypothesis (EMH), on whether the market prices reflect all known (including private) information about the economy, industry and company. Here, it discusses and concludes that the market generally reflects all known information and hence, Technical Analysis should not work. However, there are anomalies running counter to EMH such as the calendar effects and small-sized/ neglected companies producing better returns than larger companies with better analyst coverage. Portfolio Management also discusses the Capital Asset Pricing Model (CAPM), which essentially says that to get better returns, you need to take higher risks (beta). 

Risk Management (which was taught more in-depth during the Masters course) discusses what are the potential risks based on past case studies and teaches how to measure risk exposure using the Value-at-Risk method. 

The above are some of the more relevant topics to a investor. As an investor, I find the following topics to be most useful: 
  • Financial Statement Analysis (for finding companies to buy)
  • Fixed Income Analysis (for analysing bond prices & understanding bond features) - see Fixed Income blog posts
  • Risk Management (for computing risk exposure) - see Risk Management blog posts
  • Economics (for understanding how the economy works)
  • Derivatives (for understanding the effects of structured warrants) - see Structured Warrant blog post

Due to the short space allocated for each topic above, I cannot completely describe what these topics teach. Generally, the CFA curriculum is useful for providing a basic grounding on the various concepts and methods, but it does not show what an investor should look out for. As an example, after passing my CFA exams in 2006, I still have investments that were completely wiped out. However, there also have been benefits from the programme. I narrowly avoided the Mini-bonds after reading through their prospectus and understood the effects of structured warrants that were prevalent in Singapore just several years ago. See Investing Is A Life-Long Learning Journey for more info.

In conclusion, CFA builds up your foundations, but do not expect the market to give you additional respect simply because you pass your CFA exams.

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