Two Things I Wish I Knew Before I Started Investing

It has been slightly more than a year since I started investing which so happens to coincide with an unprecedented period in the stock market. However, this makes for an excellent environment to learn. In what can be considered a short span of time in the grand scheme of things, I have truly learnt a lot. So much that I can’t possibly articulate all my thoughts in a single post. In order to avoid boring you to death, I will keep it short and share two key lessons I have learnt over the past year that have brought about paradigm shifts in the way I invest.

1. The stock market is forward looking

Throughout 2020 all the way till the start of 2021, there was widespread skepticism that arose from the seemingly disconnect between the stock market and the macroeconomic numbers. How can the stock market continue to go up every single day when unemployment claims in the United States climb into the tens of millions and consumer confidence hovers around historic lows? Many, including me, were questioning whether the markets are adequately reflecting the potential for long term damage to earnings and cash flows due to the Covid-19 pandemic induced crisis.

A look at the correlation between % changes in Real GDP and US Stocks in the past 60 years can shed some light on the situation.

The graph looks like someone’s heartbeat but pay attention to the table. Note that the correlation between the stock market and real GDP in the same quarter is slightly negative. This implies that the markets do not reflect what the economy is doing today. At first glance, this seems absurd. Our intuition tells us that since the stock market depends on the earnings of the businesses and the very same businesses are the basis of the economy, real GDP and the stock market should be correlated.

However, if we consider that it is investors’ expectations that drive the stock market, things start to fall in place. When we take a look at the correlation between what the market does today and what the economy does in the following quarters, we start to see a significant positive correlation. In other words, the stock market does not reflect what the economy is doing in this time period. Instead, it tries to predict what the economy will do in the future, although rather noisily.

What I mean by noise here is that the stock market forecasts future economic growth imperfectly. If the stock market does its forecasting job extremely well, we will expect the correlation to be close to 1 (maybe 0.9, for example). However, the correlation is in fact only about 0.26. The market is doing its job of forecasting but makes a lot of mistakes. There is an old saying on wall street, that the stock market has predicted nine out of the last five recessions. Take a moment to read that sentence again. The stock market occasionally predicts recessions that never occur. These dips brought about by excessive pessimism creates buying opportunities for investors.

There are two implications of this. First, there is no use worrying about what is happening to the economy today. Since the market is a forecasting machine, today’s news has already been priced in. We should be focusing on what lies ahead of us. We need to shoot where the rabbit is going to be, not where the rabbit was. This sounds like common sense yet investors frequently do just the opposite. We must pay attention to what the market is expecting of a company and exercise independent thought to make projections of what we believe will be possible. For companies with valuations that cannot be justified by an average growth rate, the market is in effect predicting higher than average growth. What we should focus on then is whether the company is likely to beat expectations, just meet expectations or even fall short. While high growth rates are important, it is not the silver bullet to finding a great investment. What matters more is whether the company can exceed expectations.

Second, the market as a whole can be surprisingly accurate at predicting what happens next. Ever since the Covid-19 induced crash in March 2020, the stock market has been on a steady climb. The market was forecasting that vaccines can be rolled out in record time and economies will recover much faster than expected. On the other hand in November 2020, every expert was saying that there’s no chance the vaccine can be developed so quickly and there is no chance that the economy will recover that quickly. Guess who was proven to be more correct as 2021 unfolded?

Stock market: 1, Experts: 0.

This shows the value in staying the course and ignoring the noise, a reassurance for passive investors. However, this is not to say that the markets are always right. As mentioned above, it is an imperfect forecasting machine and there are times when unjustified fear causes a stock market crash. This merely creates more buying opportunities. Again, a boon for investors with a long horizon.

2. Focus on quality, not how cheap the stock is

When I first started investing, I was a bargain hunter. I was constantly looking the cheapest companies. I searched for companies with the lowest PE ratio and PB ratio.

The logic is simple. Often, stocks trading at huge discounts do so due to unwarranted reasons. When the clouds clear and investors realise that the future of the company is much brighter than they had previously thought, the stock price starts to ascend. However, I learnt the hard way that not all companies selling at low prices are good investments. Sometimes, their low prices are justified by deteriorating fundamentals such as increased competition, erosion of economic moats and a multitude of other reasons. For instance, I had invested in Perdoceo Education Corporation (PRDO), a company providing higher education. I found it cheap at the time as it was spotting extremely low PE and PB ratios. However, I failed to take into account the underlying economics of the business. The education industry was extremely competitive and PRDO was not an industry leader. Neither did it have strong economic moats, nor was there any reason to believe that things were going to be more upbeat for PRDO moving forward. I bought the stock at USD$13.40 and sold it at USD$11.86 for a 11.5% loss. Since then, the stock has gone sideways and is now sitting at $11.78.

At about the same time that I first invested in PRDO, Apple and Facebook (now Meta), two other companies I was considering, were trading at USD$130 and USD$260. I did not invest in either because I felt that they were selling at fair value and was not cheap enough. If I had invested in these wonderful companies then I would be sitting on a very comfortable gain of 30-35% today. This brings to mind a quote from Warren Buffet, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

This remains one of my biggest investing mistakes so far and it reminds me that the greatest mistakes we make are often one of omission, not commission.

PRDO could very well witness a jump in its share price if more people find that its stock is trading too cheaply as it did when its share price hit a bottom of USD$9.65. However, without improving fundamentals, PRDO will not see huge growth in earnings in the future, and shareholders are unlikely to enjoy high returns in excess of the market average. On the other hand, companies with strong and improving fundamentals will enjoy strong growth in revenue and earnings, generating market beating returns for shareholders. In the long run, this is the way to attain returns worth many times that of the invested capital.

Needless to say that my portfolio today looks quite different from a year ago. As someone who claims to be a long term investor, I am disappointed in myself as well. However, it is a testament to how my strategy has changed over the past year. Now, instead of searching for the cheapest stocks, I look for underappreciated business with strong fundamentals and excellent long term prospects. This businesses need not be ridiculously cheap, they just need to be selling with an adequate margin of safety. Is this strategy better? Only time will tell…

If you are interested in other mistakes I have made, check out this article!

Diversification – Wisdom Or Folly?

Diversification is perhaps one of the most highly contested topics amongst investors. Many super investors are of the opinion that diversification is the guaranteed road to being average. Warren Buffet once said “Diversification is a protection against ignorance… Makes very little sense for those who know what they’re doing.” However, there are many other world renowned investors that are in support of diversification. Even Benjamin Graham, Buffet’s mentor, advocates for diversification as a way to reduce portfolio risk. How can there be such contrasting viewpoints amongst a group of people with seemingly similar mindsets? In this article, I discuss the cases for and against diversification, some potential reasons behind the differing viewpoints, as well as my thoughts on diversification.

The case against diversification

Many investors such as Warren Buffet, Charlie Munger, Monish Pabrai and many more have very concentrated portfolios. The reason for doing so is to earn outsized returns and beat the market. The idea is very straightforward. In the entire stock market, there are some stocks that will lag the average and some that will lead the index by huge margins. The goal is to identify these businesses and concentrate your holdings in them. After all, if you were to diversify across hundred of stocks, you are better off just buying the index which saves on time, effort and costs. In his book, “The Dhando Investor”, Monish Pabrai encourages making few bets, big bets and infrequent bets, arguing that the results of those who place many bets, small bets and frequent bets are predictably pathetic. These investors walk the talk and have demonstrated their willingness to put a disproportionate amount of their portfolio in a few stocks. For instance, Buffet has been willing to put up to 40% of his portfolio in a single stock on certain occasions (Apple and American Express). As for Munger, his entire personal portfolio consists of just 5 holdings!

The logic here is surprisingly simple. If you are able to identify the few businesses that are going to do exceptionally well, it makes very little sense to invest in a bunch of other businesses for the sake of diversification.

However, it is important to note these investors still have a certain degree of diversification. This is a point that I will return to later on. For now, let us look at the case for diversification.

The case for diversification

Billionaire and hedge fund manager Ray Dalio, a proponent of diversification, famously created what he termed the “holy grail of investing”.

According to the holy grail, diversification can reduce risk without hurting your returns. Furthermore, the lower the correlation between the asset class, the better the effect of diversification (with uncorrelated assets giving the best effect). Ray Dalio recommends investors to find 15-20 uncorrelated streams that will allow for the most return on investment while cutting risks. Ray Dalio also recommends diversifying across asset classes, sectors, currencies, countries, and investment “styles” (like small cap, growth, etc., in equity markets).

Sir John Templeton, who’s fund averaged annual returns of 15% for 38 years, also advocates for broad diversification to guard against our own fallibility. He tells investors to expect a third of their investments to go south. In essence, these investors recognise that not everything in this world can be known. Thus, they argue that diversification is the key to build a resilient portfolio as it guards against the unknown unknowns.

Diversification exists on a spectrum

It is important to note that diversification exists on a spectrum. On one end, we can have a portfolio consisting of only one stock and on the other, we can buy the entire stock market. Additionally, risk and returns can also be placed along a similar spectrum.

Different definition of risk

The first possible explanation for the contrasting opinions on diversification could be the different definition of risk that these investors believe in. There are two main school of thoughts here. Those who favour concentrated portfolios belong to the camp that believes that risk is the probability of permanent loss in capital, while the advocates of diversification are likely to measure risk as the volatility of the portfolio (i.e. the chance of suffering a loss in a given time period). This begs the question, which definition is right? I believe that investing is a craft, not a science. Thus, there is no universally correct definition, only what is right for you. If you are like Warren Buffet or Charlie Munger who possess the ability to tune out the market noise and ignore volatility without losing sleep, risk is perhaps better defined as the probability of permanent capital loss for you. In this case, holding only a handful of businesses that you thoroughly understand can be justified. However, if you find yourself fretting over the daily ups and downs of the stock market and at risk of acting on impulse and based on your emotions, volatility is the better definition of risk for you. This is because volatility increases the risk of you acting on impulse and making a mistake (selling at the bottom or buying at the peak). In this case, it will likely be prudent to reduce volatility by diversifying broadly. Of course, this means that you may be subjecting yourself to lower potential returns, bringing me to the next point on personal goals.

Varying aims

Investors such as Buffet and Monish Pabrai pride themselves on achieving high returns in excess of the market average. Many shareholders put their money with these investors in hopes earning market beating returns. For these investors, it makes perfect sense to concentrate their portfolio in a few holdings that they believe can deliver higher returns than the market in order to maximise returns for their shareholders. On the other hand, Ray Dalio is a hedge fund manager and has structured his fund around delivering decent returns with minimal volatility. It is worth noting that investors in his fund include many pension funds. Thus, countless people rely on his fund’s returns no matter whether the stock market is up or down in a particular year. It’s money that they cannot afford to lose. In this case, diversification across a broad range of asset classes and industries with minimum correlation is the means to smoothen the ride for their shareholders without compromising on returns. Hence, the duty to shareholders also influences their strategy. In other words, the difference in their degree of diversification arises from what the investor seeks to achieve.

Conclusion: diversification for the retail investor

Unlike fund managers, we retail investors do not have to answer to shareholders. The only person we are answerable to is ourselves (and our family). This means that we are free to structure our funds according to our own definition of risk and personal goals.

If you do not have the temperament to watch your portfolio tank 40% or more during a recession without losing sleep and/or you are contented with average or slightly above average market returns, the view that the definition of risk is volatility may be most suited for you. In that case, seek to reduce the volatility of your portfolio by diversifying across various asset classes (bonds, commodities, stocks), industries and geographies. For starters, check out my article on an adaptation of the three fund portfolio to the Singapore context.

If your goal is to compound your money at upwards of 15% per year and you can stomach volatility without losing sleep, you can consider adopting the view that risk is best defined as the probability of permanent capital loss. As long as you invest in sound businesses that continue to grow, the stock price will eventually converge on intrinsic value and volatility is merely noise. However, super investors such as Buffet and Munger possess a unique ability to analyse businesses and much more resources to gather information not available to the layman. We should be humble and recognise that we cannot be a 100% sure about any investment. Hence, I believe the ideal diversification (based on the definition that risk is the chance of permanent loss, not volatility) lies somewhere in between the concentrated portfolios of super investors and buying the entire index. My personal preference is to have 10 to 15 stocks, with no more than 10% of my portfolio in a single holding.

In fact, there is nothing that is stopping us from doing both. We can allocate a sizeable chunk of our portfolio to index tracking ETFs (for instance 50-80%, depending on our preferences) and have the rest in a handful of businesses that we believe are undervalued. This portfolio may not achieve returns in excess of 20% but it can still deliver slightly better than average returns, as proven by Ray Dalio and Sir Templeton, who both edged out the market over extremely long periods of time while maintaining a high degree of diversification.

What matters then is to choose a strategy that is aligned with your personal goals and temperament. This way, we will be able to stay the course even in difficult times that test our faith.

If you found this article useful, consider joining The Dollar Sapling telegram channel for more resources!

Three Fund Portfolio – For Lazy Singaporeans

For those who have been following my website for a while, you will know that I am a huge proponent of passive investing. This strategy involves buying and holding ETFs that track a broad index. The philosophy behind this strategy is encapsulated in this quote from John Bogle, the founding father of modern day index funds: “don’t look for the needle in the haystack, just buy the haystack!”. In today’s complex and uncertain world, keeping our investment strategy simple is perhaps one of the wisest things we can do.

Proponents of this method of investing, known as “bogle heads”, have popularised a three fund portfolio that is inspired by John Bogle’s simple and low cost investing strategy. Typically, a three fund portfolio consists of the following:

  1. U.S Stocks
  2. International Stocks
  3. Bonds

However, given that this portfolio was created with the U.S. context in mind, I have adapted the three fund portfolio to suit my personal goals and preferences and Singapore’s unique context (many blue-chip stocks and REITs, no withholding taxes on dividends and the CPF system).

Here is an outline of the three fund portfolio adapted for Singaporeans.

1. An ETF that tracks a broad index

When it comes to passive investing, there is a plethora of ETFs to choose from. For starters, choose which index you would like to track. For instance, there is the S&P 500 index, the total U.S. stock market, the Russell 1000 index, world indices, etc.

If you would like to invest exclusively in the United States, your choice will be between the S&P500 index, the total U.S. stock market and the Russell 1000 index. From here, it will depend on whether you would like some exposure to small and mid cap stocks. If you do, pick the total U.S. stock market fund. Else, the S&P500 and Russell 1000 index are fine as well.

If you believe that the other markets could provide greater returns than the United States in the years to come, I would suggest opting for an ETF that tracks a world index. These indices typically have about 60% allocation to the United States and a 40% exposure to the rest of the world, providing adequate diversification away from the United States.

The ETFs I picked for my own portfolio are CSPX, which tracks the S&P500 Index and VWRA, which tracks the FTSE All-World Index. Both of these ETFs are Irish-domiciled ETFs, which are more tax efficient for Singaporeans compared to their US-domiciled counterparts. Additionally, they are of the accumulating type as I would like to maximise the compounding effect while minimising costs. For more information on Irish-domiciled ETFs and how to choose one that suits your preferences and goals, check out my article here.

For investors who only wish to pick one ETF, I would go with VWRA because it provides greater diversification and exposure to emerging markets such as China as well.

2. Singapore Dividend Stocks

One of the advantages of investing in Singapore is that there are many high dividend yielding stocks (blue-chip stocks and REITs) and no taxes on dividends. This is why so many Singaporeans are obsessed with dividends (myself included). While dividend stocks may not produce spectacular capital gains compared to high growth companies in the United States, I would argue that there is still a place in our portfolio for them. In investing, we should not seek to maximise our returns but instead seek to build a resilient portfolio that generates adequate returns. These dividend stocks are typically more stable and continue to pay dividends during times of economic downturn (albeit less). A steady stream of dividend income is extremely desirable as it can help tide us over a crisis or challenging period. The Covid-19 Pandemic is the perhaps the perfect example to substantiate my point.

In terms of dividend stocks in Singapore, there are two main ETFs to consider.

  1. SPDR STI ETF (Ticker: ES3)
  2. Lion Phillip S-REIT ETF (CLR)

As I am not a fan of the Straits Times Index (STI), I invest directly into the banks (OCBC, DBS and UOB) instead (mainly because they have higher yields than the STI and tend to perform better). If you would like to stick with the most passive form of investing, dollar cost averaging into the STI is fine as well.

Additionally, the S-REIT ETF is an excellent ETF to include in your portfolio. It boasts a higher dividend yield than the STI and Singapore’s vibrant REIT market is definitely something that we should take advantage of. Read my article on REITs to find out why I think they remain a worthy investment today.

At this point, some of you might say that my portfolio has more than three funds and deviates from the most passive form of investing (buy and hold ETFs). However, I would argue that the additional work required to invest in the banks and the S-REIT ETF is minimal and well worth it. Furthermore, no harm in having greater diversification! That being said, there is nothing wrong if you wish to stick with only three funds, just pick either ETF (STI or S-REIT) and stick with it.

3. CPF

Lastly, I have opted to replace bonds with the retirement system that Singaporeans have a love-hate relationship with. Despite the limitations of CPF, namely not being able to receive any pay outs until much later in life, CPF has “bond-like” characteristics that makes it a suitable replacement. Let me explain my thesis.

Firstly, I have an extremely long term horizon as I am investing for retirement. Thus, the fact that I am not able to touch my CPF money does not bother me as I have the intention of leaving the money in there for as long as I can. Of course, there is a chance that I will need cash urgently (due to a recession or emergencies). This makes the case of first having an adequate emergency fund.

Next, CPF provides a 4% rate of return that is essentially risk free (as it is guaranteed by the Singapore government which is rated triple A, the highest possible credit rating). This is much in excess of any triple A rated bond in the world.

Essentially, the CPF system makes it a bond on steroids that can give us steady, guaranteed pay outs well into our retirement as long as the Singapore government does not default. Given our government’s history of prudence and huge reserve, this is extremely unlikely.

Even if you are intending to pursue FIRE, CPF can be your safety net, allowing you to still achieve an adequate retirement in the event that your FIRE plan falls through.

Either way, we are forced to make monthly CPF contributions from our salary, which should be form quite a substantial part of our portfolio. However, if you want to allocate a larger portion of your portfolio to CPF, you can make voluntary contributions which can lower your taxable income as well.

That being said, I would like to add a caveat that I am mainly investing for retirement. The CPF system should only be seen as a replacement to bonds if you have an extremely long term horizon. If you are intending to take money out to make a big ticket purchase, consider having greater allocation to stocks and actual bonds.

Thus, a Singapore three fund portfolio will look something like this:

  1. VWRA
  2. STI ETF or S-REITs ETF
  3. CPF

Finally, we come to portfolio allocation.

Below are rough guidelines I intend to use to portion my portfolio at different stages of my life. Do note that these just rough numbers and are subjected to change depending on numerous factors.

In my 20s, I intend to be aggressive as I wish to attain financial independence as early as possible. Thus, I have a huge allocation to U.S. and international stocks (VWRA and CSPX). I also have a small allocation to Singapore REITs and blue-chips (namely the bank stocks), which I picked up last year when they were at huge discounts. Finally, my CPF makes up less than 10% of my portfolio as I am not working yet. Currently, my portfolio looks something like this:

US + Rest of the world: >70%

Blue-chips and REITs: 20%

CPF: <10%

For the next 5-10 years, my portfolio will likely look similar in terms of allocation. I intend to continue to DCA monthly into CSPX/VWRA, only adding to Singapore REITs and blue-chips if they are selling at huge discounts.

In my 30s-40s, CPF as a percentage of my portfolio will likely increase substantially due to mandatory and voluntary contributions. At the same time, I will start to allocate more money to dividend stocks and cut back on growth stocks in order to start building a dividend income in order to achieve financial independence. My portfolio will likely look something like this:

US + Rest of the world: 40-50%

Blue-chip and REITs: 30-40%

CPF: 20%

In my 50s and beyond, I will hopefully have achieved financial independence. I intend to do this by having the bulk of my investments in dividend paying stocks. This will allow me to have a steady stream of dividends to fund my desired lifestyle. However, I will still be allocating some money to growth stocks so that my portfolio will still achieve desirable rate of return.

US + Rest of the world: 10%

Blue-chips + REITs: 60%

CPF: 30%

As with most other things in life, there are no hard and fast rules in investing. What may work for someone else may not work for you. I adapt ideas from other successful investors, copying what I deem fit and omitting the rest. In fact, my own plans, preferences and goals may be subjected to change and so will my portfolio allocation as well. The key is to remain flexible in order to create a resilient portfolio that works for you.

Real Estate Investment Trusts (REITs)

The Singapore Stock Exchange hosts a vibrant ecosystem of Real Estate Investment Trusts (REITs). From homegrown names such as CapitaLand to foreign REITs such as Manulife US, there is a plethora of REITs for us to pick from. In this article, I will cover the basics of REITs and what makes them a great investment vehicle for building long term wealth.

What are REITs?

REITs, or Real Estate Investment Trusts are companies that own income-producing real estate across a range of property sectors. The shares of such REITs are traded on stock exchanges just like those of a typical business, giving the shareholders a right to a small portion of the rental income the REITs collect from renting out their properties.

REITs structure

Before investing in REITs, it is essential that you understand the typical process of how a REIT operates in Singapore.

  1. Unitholders and REIT sponsor come out with initial capital
  2. REIT manager is employed to manage the group of properties
  3. REIT manager receive fee for its asset management service
  4. Capital employed to acquire income-producing properties
  5. REIT manager hires team of property managers to run day-to-day operations
  6. Property managers receive fee for services provided
  7. Net property income is deposited in trustee’s account
  8. A trustee is employed to safeguard unitholders’ interests. Trustee only release funds when property deeds are properly accounted for and verified
  9. Trustee earns fee for services provided
  10. Unitholders (you and I) receive income distributions every 3 or 6 months

For a more detailed explanation of how REITs in Singapore work, read this article.

Reasons you should invest in REITs

1. Allow retail investors to take part in the wealth creation by the real estate sector

Of the 10 richest people in Singapore, 5 of them derived their wealth partially or wholly from real estate. This is a testimony to the wealth that the real estate sector can create. While investing in REITs will not make us a millionaire overnight, it allows us to take part in the wealth creation of real estate. This is because REITs make investing in real estate affordable and accessible to retail investors. Few people will be able to fork out millions to invest in real estate but REITs will allow us to gain exposure to real estate investments with only a few hundred dollars.

Granted, past performance does not guarantee future performance. However, there are many factors that point towards a buoyant real estate sector in the years to come. First, Singapore’s land is scarce, limiting the supply of real estate. Additionally, as a politically stable country with a business friendly government and high skilled workforce, Singapore remains an attractive location for many businesses to set up their operations. Thus, Singapore continues to enjoy strong demand for real estate. These factors exert an upward pressure on rental and property prices. With many multinational corporations looking to enter the ASEAN market and the rise of high tech manufacturing, Singapore’s real estate sector will likely continue to enjoy tailwinds for the foreseeable future.

2. Pays good dividends

REITs in Singapore are required to distribute 90% of their taxable income to unitholders to qualify for tax transparency treatment. Under this treatment, the REITs are not taxed on income distributed to shareholders. Essentially, this regulation encourages REITs to pay higher dividends. This is why REITs have such high dividend yields compared to other blue chip companies. For instance, S-REITs (Singapore REITs) average a dividend yield of 5.6% in April 2021. This is very impressive compared to the 3-4% dividend yield of the Straits Times Index, which tracks the 30 largest public listed companies in Singapore.

Furthermore, unlike the United States which levies a 30% withholding tax on dividends for non-residents, Singapore does not tax dividends. This means that what we see is what we get. The dividend paid by REITs go straight into our pockets!

3. Provides diversification away from stocks

The third reason to include REITs in your portfolio is that it provides some diversification away from stocks. Despite their slight correlation, a mixture of REITs and stocks will make your portfolio less volatile (as observed from the graph below).

Some may argue that REITs do not provide sufficient diversification away from stocks due to their correlation, citing the example where both stocks and REITs alike suffered greatly during the 2009 financial crisis. However, this observation fails to take into account the underlying reasons of the 2009 financial crisis. The 2009 subprime mortgage crisis stems from the real estate bubble and was one that affected the entire world economy. Thus, it is to be expected that both stocks and REITs will be similarly impacted. On the other hand, in instances such as dotcom crash in 2000, stocks suffered greatly while REITs continued to deliver solid returns. This is because the dotcom bubble was mainly confined to technology stocks. In cases such as this, REITs do serve as an adequate diversification away from stocks. For additional reading on the correlation between REITs and stocks, check out this article.

4. REITs are relatively stable

The stability of REITs can be attributed to the stringent regulation implemented by the Monetary Authority of Singapore. One of which, is the maximum gearing ratio (debt-to-equity) of REITs. In essence, this regulation limits the amount of debt REITs can take. In light of the Covid-19 Pandemic, the Monetary Authority of Singapore raised the gearing ratio limit for REITs from 45% to 50%, giving REITs more leeway to take on more debt in these trying times. If you think about the ongoing Evergrande saga, excessive debt will make a company more risky.

Additionally, there are many more intricate details of the regulation of REITs in Singapore. These regulations are outlined by MAS and can be found here. In my opinion, these regulations are very desirable as they make the REIT environment in Singapore controlled one. This protects retail investors (you and me), making REITs relatively stable investments for investors seeking passive income.

Limitations of REITs

  1. Securitization of REITs resulted in them behaving like stocks

Much like stocks, REITs are traded on a stock exchange and volatility. This is unlike traditional real estate, which have relatively more stable prices.

  1. May not experience that much growth

This is because majority of earnings are paid out as dividends and are thus not reinvested to achieve more growth.

That being said, I would not see these as disadvantages or risks of REITs. The two points above come as a trade-off, something like a necessary evil for us to take part in the real estate investment and enjoy the high dividend yields synonymous with REITs.

The simple way to invest in REITs

Those who have been following my blog for some time already know what I am going to say. As I have previously wrote in my article titled “How To Start Investing With Little Money”, ETFs are the perfect way for the novice and/or lazy investor starting with a small capital. With as little as a $107 dollars at the time of writing, you can gain exposure to 27 high quality REITs in Singapore by investing in the Lion-Phillip S-REIT ETF (ticker: CLR).

For a more in depth comparison between the 3 REITs ETF that are listed on SGX, refer to this Seedly article.

Finally, I would like to end of this post by debunking a common misunderstanding that REITs are for those nearing retirement and unable to take on greater risks. In my opinion, there is a place in everyone’s portfolio for stable income producing assets such as REITs. The pandemic is perhaps the best argument for this as stable dividend pay outs can potentially tide us over a tough period. As usual, the exact proportion of your portfolio allocated to REITs should be tailored to your personal goals and preferences. Join my telegram channel here where I share more of my research!

Irish Domiciled ETFs

If you have read my previous posts, you will know that I am a proponent of passive investing (AKA buy and hold ETFs). In this article I will be sharing the ETFs I personally dollar cost average into, which are known as Irish Domiciled ETFs. Without further ado, let us jump right in.

What are Irish Domiciled ETFs?

The common S&P500 ETFs such as SPY and VOO are domiciled in the United States. Which means they are registered and regulated in the US. These Irish domiciled ETFs are thus registered and regulated in Ireland. This is not to be confused with their place of listing as Irish domiciled ETFs are typically listed on the London Stock Exchange. Meaning that an ETF can be domiciled in one country and listed in another.

Why does the country that an ETF is domiciled in matter?

  1. Withholding Tax

The short answer is that it matters for tax efficiency. As a non US resident, we are subjected to a withholding tax of 30% when dividends are paid from a stock or ETF domiciled in the US to us. However, due to a tax treaty that exists between the US and Ireland, the withholding tax can be reduced to 15%. Here is how it works.

When dividends are paid from the S&P500 companies to a US domiciled ETF such as SPY or VOO, there will be no taxes. However, when the dividends from the ETF is paid out to us, there will be a tax of 30%. As for Irish Domiciled ETFs, the US-Ireland tax treaty will reduce the withholding tax to 15% when the S&P500 companies pay the dividends to the Irish Domiciled ETFs. As Ireland does not have a withholding tax for foreigners, we will not be taxed when we receive the dividends from these ETFs. This means our effective tax rate will be reduced from 30% to 15% simply by purchasing Irish Domiciled ETFs instead.

  1. Estate Tax

While we are on the topic of taxes, another tax that the US levies is the estate tax, which is basically a tax on all of your assets located in the US when you pass on. This includes property, shares of US companies and cash (even cash in US brokers such as IBKR!). As you might have guessed, because Irish domiciled ETFs are not regulated in the US, they are exempted from the US estate taxes. For a rough idea of how much estate taxes can add up to, here are the estate tax rates from the IRS.

From the table above, if you have 1 million worth of assets domiciled in the US, the estate tax will amount to a WHOPPING $345,800! Thus, Irish domiciled ETFs is one way to minimise the impact of the US estate taxes.

Now, you may be wondering why I am taking this into consideration at such a young age. This is because I intend to continue dollar cost averaging into ETFs tracking the S&P500 and hold for a long long time (basically my whole life). This means if anything were to happen to me (touch wood), I may not have time to make arrangements. The last thing I would want is my dependents having the shock of their lives when the IRS sends them a bill for hundreds of thousands of dollars. Life always seems to throw a curve ball when we least expect it, so it is good to plan for the unexpected.

  1. Accumulating ETFs

Accumulating ETFs are ETFs that automatically reinvest the dividends. The typical US listed ETFs are distributing, meaning they pay the dividends out to shareholders and it seems like there are no accumulating ETFs in the US. I am guessing this is due to withholding taxes and perhaps other reasons. On the other hand, there are many accumulating Irish domiciled ETF options.

As someone who wants to maximise the compounding of my investments, accumulating ETFs are a fuss-free and cost effective solution. Instead of having dividends paid out to me and having to reinvest manually through a broker which will incur additional commission fees, accumulating ETFs will help me do this automatically and save on fees as well. Furthermore, as the dividends I receive are not much, I may not be able to buy complete shares of ETFs. With accumulating ETFs, I do not have to worry about buying complete shares as the dividends are all reinvested, no matter how little.

The two screenshots above compare an accumulating ETF (CSPX) with a distributing one (VUSD). Both track the same index (S&P500) and have the same expense ratio (0.07%). As you can see, the dividends that are automatically reinvested show up in higher capital gains (about 17% in the last 5 years).

All that being said, there are some cons to Irish domiciled ETFs as well.

Firstly, Irish Domiciled ETFs will have lower trading volumes and thus have a higher bid-ask spread than their US counterparts. This can be considered a hidden fee of sorts.

Secondly, the commissions for LSE will likely be higher than that of the US markets.

However, both commissions and bid-ask spread are upfront costs paid when we purchase a stock. On the other hand, lower withholding taxes and automatic reinvesting of dividends are recurring cost savings. Not to mention the astronomical estate taxes that we will be avoiding in the future. Thus, all things considered, Irish domiciled ETFs will still be more cost effective in the long run, maximising our returns.

Choosing a broker

If you are convinced about the benefits of buying Irish Domiciled ETFs instead of the US domiciled ones, you will need to choose a broker to get started. When I was first doing my research, I shortlisted SAXO markets and Interactive Brokers (IBKR) based on these criteria:

  1. competitive trading commission fees
  2. zero or low management fees (ideally zero of course)
  3. trustworthiness

Here is a quick comparison and my final verdict:

Previously when IBKR charged USD$10 monthly minimum fees for accounts with total asset value less than $100,000, SAXO markets was more cost effective for investors with assets less than $100,000 and IBKR was the cheaper option for those with assets more than $100,000. Since then, IBKR has removed their inactivity fees. This makes them the best brokerage to purchase Irish Domiciled ETFs in my opinion. The only downside is that IBKR’s interface can be slightly hard to navigate initially and takes some getting used to.

choosing an etf

To conclude this rather long article, here is a comparison between some of the common Irish Domiciled ETFs and how I go about picking the ones that suit my portfolio and personal preferences.

First, let us start with the ETFs that track the S&P500.

Personally, I look out for a combination of low fees and accumulating type. This is because I do not require the dividend pay outs at the moment and wish to reinvest everything in order to maximise compounding. This leaves CSPX and VUAA, both of which are accumulating and have extremely low fees of 0.07%.

The main differences would be the share price and volatility. CSPX is currently priced at USD$456.42 while VUAA is priced at USD$82.20. Thus, if you are DCA-ing less than USD$460 (SGD$621) a month, VUAA would be the obvious choice.

The trade off would be that trading volume of CSPX is much greater than that of VUAA, meaning that VUAA will have higher bid-ask spreads. However, as mentioned above, these fees should not be a cause for concern in the long run.

In the end, I decided to go with CSPX by DCA-ing every 2-3 months instead of monthly so that I will be injecting a larger capital each time. I do so to keep trading commissions low. Else, just buy VUAA and don’t worry about the spread.

The next group of ETFs track world indices.

As mentioned above, I favour the accumulating options. Thus, my choice was between VWRA, ISAC and SWRD.

I chose VWRA because compared to the other two, it gives me slightly more diversification away from the US market and greater exposure to emerging markets such as China. This suits my portfolio considering I already buy CSPX.

While there may be a myriad of ETFs to choose from, my advice would be not overthink it. No point wrecking your brains over which ETF to choose because any of these are excellent options to form the core of your portfolio. As usual, the most important thing is to pick an ETF, start dollar cost averaging and stay the course.

Click here to join The Dollar Sapling telegram channel where I will be sharing more about passive investing and ETFs!

How To Invest Your First Dollar

One way to set yourself up for financial success in the future is to build a diversified investment portfolio and take advantage of compound interest. This is a beginner’s guide on how to channel your income from part time jobs and side hustles towards investing for your future. This article is written in collaboration with @gapyearsg, check out their page here for career tips, job opportunities and more resources!

1. Choose a brokerage

When you are just starting out, you are likely investing small sums of money. This means that large commissions will eat into your returns substantially. Thus, it is wise to choose the lowest cost broker. Personally, I use tiger brokers because they have extremely competitive fees for Singapore and US-listed stocks. Additionally, creating an account is fuss-free and their interface is easy to navigate. Other options include MooMoo that also provide very competitive fees and have an attractive sign up bonus. Here is a quick comparison between the cheapest brokerages.

For more information on the respective brokers, check out this Seedly article on the cheapest online brokerages in Singapore.

My advice here is to not ponder too hard on which brokerage to use. Choose the one with the lowest fees and move on. It’s more pertinent that you get started on investing than fall prey to the paradox of choice.

2. Choose an ETF to invest into

The next step is to choose a suitable ETF to invest in. For starters, I recommend choosing an ETF tracking a broad index such as the S&P500 or the world index. This is also known as passive investing where you try to replicate the market returns. The beauty of this method is that it is time and cost effective. Instead of spending hours reading annual reports and researching on individual companies, buying the whole index will allow you instantly have a sufficiently diversified portfolio that is going to give you decent returns. Furthermore, ETFs are very low cost investment products, having average fees of just 0.40%. These two reasons make ETFs the most efficient way of investing, allowing you to earn average market returns with minimal time, effort and money. For more reasons why ETFs is a great investment vehicle for starters, check out my article on how to start investing with a small capital.

While passive investing may seem boring, consider the fact that 90% of investors fail to beat the market. This shows that it is not that easy to beat the market and that average returns are not so average after all! As beginners, we should be contented with earning the average market returns and ETFs will allow us to do so with minimal effort. This will also free up your time so that you can pursue your interests and focus on your part time jobs or side hustles.

In order to help you with your decision, here is a simple comparison of some of the popular ETFs.

All 3 of these ETFs are sufficiently diversified and are suitable to be the core of any investor’s portfolio. The main difference between the 3 ETFs is the exposure to the United States market. Although both VOO and VTI will give you 100% exposure to the US, VTI is slightly more diversified as it includes the entire US market while VOO will only give you exposure to the top 500 companies in the US. Alternatively, if you would like greater geographical diversification, URTH is the one for you as it has exposure to other developed markets such as Japan, United Kingdom, France and many more. However, this will come at a greater cost of 0.24% compared to just 0.03% for the other two.

Once again, there are countless options to choose from. While it is important to choose the right ETF for you, don’t ponder for too long. What’s more important is that you choose a sufficiently diversified ETF and start investing.

3. Dollar cost average (DCA) monthly

Dollar cost averaging refers to an investment strategy in which an investor divides up the total sum to be invested across periodic purchases of the target asset in order to reduce the impact of volatility on the overall purchase. This is a popular strategy used by many to reduce the impact of unavoidable and unpredictable market volatility on their portfolio. DCA is an effective strategy that removes emotion from the decision making process, allowing us to avoid timing the market. Just have the conviction to stay the course and continue to invest every month without fail. Even if the market crashes tomorrow or a year from now, just keep purchasing ETFs at a cheaper price and you will be rewarded in time to come. For more information on DCA, read my other article here!

4. Sit back and let compound interest do the work

By working a part time job 8 hours a day for 5 days a week, you will earn about $1,600 a month assuming a pay of $10/h. By setting aside $600 a month to invest, you will end up with $7,200 invested after a year. Assuming that you do not make anymore contributions, your $7,200 will grow to more than $20,500 by the time you are 30! Let us now take a look at how much of a difference four years will make. If you had invested the same $7,200 at age 23 instead (after you finish your degree), your portfolio will only be worth $14,000 by the time you are 30. That’s a difference of more than $6,000 simply by starting to invest before you begin you university study instead of after! By working a higher paying job, cutting your expenses and having a side hustle, it is possible to save and invest more. This will put you in an extremely desirable position financially. Furthermore, if you continue to work part time while studying and make monthly contributions, your portfolio will grow exponentially.

That being said, investing is merely a means to an end. As Robert Kiyosaki said “It’s not how much money you make, but how much money you keep”. Thus, we should continue to improve our financial literacy in the mean time so that we can make better decisions in the future. If you would like to learn more about personal finance and investing, click here to join The Dollar Sapling telegram channel where I share more resources and articles.

How to Start Investing With A Small Capital

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.

Dollar Cost Averaging

Dollar cost averaging refers to an investment strategy in which an investor divides up the total sum to be invested across periodic purchases of the target asset in order to reduce the impact of volatility on the overall purchase.

This is a popular strategy used by many to reduce the impact of unavoidable and unpredictable market volatility on their portfolio. Let us delve into the math to see exactly how it works.

Say for example that the share price of company ABC is $100. From January to February, unfavourable news of ABC is published and the stock price falls from $100 to $50 (a 50% decrease in price). However, the fundamentals remain sound and the stock recovers back to its original price from February to March (a 100% increase in price).

Tom, unaware of what DCA was, decided to use his entire capital of $10,000 to purchase 100 shares of ABC at the start January. By the end of March, he would have just broke even (assuming that he did not panic and sell during the 50% drop, which requires much conviction).

Jerry, on the other hand, read about DCA on a blog post and decided to employ it. Let us see how his investment has done during the same period.

In January, Jerry used $5,000 to purchase 50 shares of ABC (at a cost per share of $100). From January to February, the value of his investments would have fallen by 50% (from $5,000 to $2,500).

At the start of February, Jerry remains convinced that the fundamentals of the stock has remained unchanged, and that ABC is severely undervalued at $50. Thus, he invested the remaining $5,000 into ABC, purchasing an additional 100 shares. He now owns 150 shares for a total cost of $10,000, reducing his cost per share from $100 to $66.67 ($10,000/150). As the price rises back to $100 from February to March, the total value of his investment is now $15,000 ($100 x 150 shares).

His total investment of $10,000 is now worth $15,000, earning a 50% return on his investment thanks to this nifty trick!

You may be wondering, why not wait for stock to crash 50% before entering a position? This way, when the share price doubles (as in the above example), you’ll earn a return of 100%! This is because one can never tell where the price of a share will head in the near term. No one can state with 100% certainty whether the price of a share will rise or fall tomorrow.

Let us now take a look at how DCA can be employed in the real world. The calculations below shows how an investor’s portfolio would have performed if he had invested $5,000 into an ETF tracking the S&P500 index at the start of every year from 2000 till 2021.

As you can see, despite entering the market at the height of the Dotcom bubble and investing through the Global Financial Crisis and Covid-19 pandemic bear market, the investor still made money as long as he stayed the course and invested $5,000 regularly. In fact, he tripled his total contributions!

All too often, investors fall prey to their emotions. They get greedy when they see huge run ups and panic when they see huge declines (as depicted below). This results in them buying at the top and selling at rock bottom. This is how most investors lose money.

Dollar Cost Averaging is thus an excellent strategy to remove emotion from the equation and drown out the noise of the market. As long as we are committed to investing at fixed time intervals, we will not panic sell when crisis strike and instead accumulate more shares at a cheaper prices.

That being said, there are some caveats when implementing DCA:

  • higher transaction cost
  • you may end up buying more shares of a business that is deteriorating

With respect to the first point, one must strike a balance and not over trade. This is because excessive trading will cause fees to add up and eat into our returns. One method is investing in ETFs/blue-chip stocks regularly every month or quarter (instead of every week). Another method when investing in individual companies is to use DCA when the prices drop substantially (10-20%).

The second point highlights the importance of understanding the fundamentals of a company before investing in it.

Sometimes, unfavourable news such as lawsuits, fines or missed earnings/revenue estimate may cause the stock market to over react, resulting in the share price of the company to fall by 10, 20 or even 30%. Often, investors will panic and sell out of their position, only to see that down the road, the share price hits new highs.

However, there are times when the decline in share price is justified by the deteriorating fundamentals of the business. For instance, with the onset of E-commerce, many retail businesses that are unable to keep up with the trend are seeing their profits being eroded and blindly buying more of these businesses because of DCA is a losing strategy.

Thus, an intelligent investor will first access whether the fundamentals of the company has been affected by asking himself questions such as the following.

  • Is the situation is a one-off event or one that has lasting impact on the company?
  • Has the ability of the company to earn money has been affected?

If the impact is temporary and the business model remains intact, the investor should have the conviction to hold or even buy more shares to lower his average cost. However, if the fundamentals are indeed deteriorating, the investor should then sell out of his position and take the loss instead.

Thus, understanding a business (or the index) is key to implementing DCA effectively.

To end this post, I would like to emphasize the importance of having a plan when investing. Without a plan, we are vulnerable to our greatest enemy, our emotions.