If you have read my other post on The 8th Wonder of the World – Compound Interest, you would have understood the importance of investing as early as possible. However, there can be many reasons that impede one from investing early. Common reasons include lack of time, money and knowledge. Thus, I am going to share with you my personal story of how I started investing and how you can, too.
As investing is only a means to an end (with the end being financial independence), it is crucial that you check out my other post on how to embark on your journey to financial independence and make sure that you have completed the steps I shared in that post before investing.
First, let me share the 3 biggest challenges I personally faced when I started to invest with a small capital.
1. Insufficient funds for diversification.
Each time that you wish to purchase shares of a company, the minimum you have to purchase is one lot of shares. In the United States, one lot of share is one share. However, the lot size of Singapore listed companies is 100 shares. Thus, if I wish to purchase shares of DBS, I would have to buy a minimum of 100 shares. At the current price of $30, one lot of shares will cost $3,000 (100 x $30). If I were just starting out with $5,000, DBS will take up more than half of my portfolio, leaving me with insufficient funds to diversify my portfolio sufficiently.
2. Commission fees were eating into my returns
The need for diversification combined with a small starting capital also means that each position in my portfolio would be relatively small. For instance, if I wanted to maintain diversification by investing $5,000 equally across 10 companies, I would only have $500 for each company. Thus, commissions would be a large percentage of each position. When I first started investing, I used a non-custodian broker that charged $25 per trade (non-custodian brokers usually charge higher fees than custodian brokers). If I were to buy one lot (100 shares) of Frasers Centrepoint Trust which has a share price of $2.30 at the time of writing for $230, $25 would be 10.9% of my purchase. The average cost of each share would thus be ($230+$25)/100 = $2.55, 10.9% greater than the market price. Essentially, I have instantly made a 10.9% loss on my investment just by buying it. Of course, the average cost could be lowered by making a bigger purchase as the same commission of $25 would be spread out over more shares. However, as I was just starting out, I did not have the luxury of buying many lots as the need for diversification means that I cannot have too much of my portfolio in a single stock. Thus, this reduced my returns on investment substantially.
3. Lastly, I did not have sufficient knowledge to choose many stocks and did not have much time to expand my knowledge.
As one of the best investors in the world, Warren Buffet, always says “invest in companies within your circle of competence”. This means that you should invest in businesses that operate in industries you understand. This can be the industry which you work in or companies you interact with daily because your career experience will equip you with knowledge of the industry that an outsider will not have. As a customer, you will have first-hand knowledge of the product or service the company provides. As someone serving National Service, my circle of competence is unsurprisingly small. While it possible to widen your circle of competence by doing research, it is very time consuming to do so. As I spent 5 days a week in camp, I had to do most of my research over the weekends. Amidst juggling to spend time with my family and friends and pursuing my interests, I did not have much time to do much research. As such, my research on a single company would span several weekends and the list of companies that I wanted to look into never seem to end. Thus, I made very slow progress in finding great companies to invest in.
Reflecting on these challenges, this is how I would have invested differently if I could go back in time: I would have dollar cost averaged monthly or quarterly into ETFs. An ETF is a security that tracks an index, sector, commodity, or other asset, which can be purchased and sold on the stock market like a normal stock. For instance, the S&P500 is a stock market index of the largest 500 companies listed on the stock exchanges in America. By purchasing one share of an ETF that tracks the S&P500 index, you will essentially own very small percentages of the 500 largest companies in America. As the share price of the companies that are part of the index go up, so will the price of the ETF. In Singapore, there are also ETFs tracking the Straits Times Index (STI), which tracks the performance of the 30 largest companies listed on the Singapore Stock Exchange.
From the get go, an ETF will solve the first issue of having insufficient diversification as an ETF that tracks a stock index is highly diversified. By buying a single share of an ETF tracking the STI, you will own shares in many great companies such as DBS, OCBC, UOB, CapitaLand and many more.
At the same time, the fact that I do not need to worry about my portfolio being too concentrated means that I can buy multiple lots of an ETF at a time. This means the commissions would be spread out across more shares, reducing my average cost. For instance, the SPDR Straits Times Index costs $3.113 per share at the time of writing. As I need not worry about diversification, I could purchase 10 lots (1000 shares) for $3,113. With the same commission fee of $25, my average cost would be ($3113+$25)/1000 = $3.138. This is only 0.8% higher than the market price, resolving the second issue. However, as I prefer to use a dollar cost averaging method and only invest a few hundred month, a commission of $25 per trade is still substantial relative to the size of each trade. Thus, I would have used a custodian broker instead of a non-custodian one in order to minimise commission fees. Another method is to invest quarterly instead of monthly. By spreading out my purchases, I will buy less frequently and each purchase will be larger. Thus, commission fees as a percentage of total value of purchase will be smaller. As a rule of thumb, I try to keep my commission fees below 1% of my purchase.
Finally, as an index such as the S&P500 tracks the largest 500 listed companies in America, if one company falls out of the top 500 companies, it would be replaced by another company. Essentially, my portfolio would be automatically maintained as the index is rebalanced. This means that I do not need to devote much time into researching companies, overcoming the third difficulty I had faced. The S&P500 is also commonly used as the benchmark for the average stock market returns. While it is natural to seek returns that are as high as possible, we must remember that investing is not a get rich quick scheme. As beginners, we should be contented with returns equals to the average of the stock market. That is a sustainable and safe way to build wealth over the long term. In fact, research has shown that 90% of investors fail to beat the stock market. Average returns are not so average after all.
Even if you do not wish to jump straight into investing, I highly recommend you to start saving and learning more about investing now. Understand the risks involved and some crucial concepts such as compound interest.
To sum it up, ETFs provide diversification, reduce fees and save time, making it suitable for a beginner’s portfolio.