How should you invest?

I had previously written a post on it, but I realised that the post was tailored to only young executives with an aggressive risk appetite. You can check the post out: here. On the other hand, this post will be more neutral and tailored to the retail investor of various risk profiles.

Determining your risk profile

Before you start to invest, you must first make sure of two things. One, that you have already set aside 6 months of emergency funds. This funds are not for investing, and is a rainy day fund. Two, that the money set aside for investing is money you can lose. Meaning, you cannot depend on it to pay your bills or mortgages.

Only after you have made sure of this, then you have a capital to start investing. Now, you will need to do a risk profile test. In other words, you need to find out your risk profile. The purpose of the risk profile is not to give you better returns, but to make sure that you can sleep well at night. If you cannot sleep, just because your investments have lost 5% of their value, then you are better off putting your money in the bank buying fixed deposits, or buying the Singapore Savings Bond. You can use this risk profile questionnaire by HSBC: here.

Asset allocation

Taking the risk profile questionnaire should give you a risk profile rating of 1 to 5, with 1 being the most conservative, and 5 being the most aggressive. Please note that you might not agree with the risk profile, and remember what I will say now.

If you think that you are more conservative than the risk profile result, then use the more conservative estimate of your risk profile. However, if you think that your risk appetite is more aggressive than the result, then please stick to the result given.

Only after determining your risk appetite, then you are ready for the next part of investing: asset allocation. I have used this link by Vanguard which tells you the asset allocation for each risk profile: here. To use the results from the risk profile questionnaire, use this table.

Risk profile (from HSBC)	Investor type (from Vanguard)	Asset allocation (from Vanguard)
1 – very conservative	Income	100% bonds, or 20% stocks and 80% bonds
2 – conservative	Income to balanced	30% stocks and 70% bonds, or 40% stocks and 60% bonds
3 – balanced	Balanced	50% stocks and 50% bonds
4 – moderately aggressive	Balanced to growth	60% stocks and 40% bonds, or 70% stocks and 30% bonds
5 – aggressive	Growth	80% stocks and 20% bonds, or 100% stocks

On a side note, you may also want to use the risk profile questionnaire by Vanguard, which gives you the target asset allocation directly: here. But note that you will not be able to know the category of your risk profile.

Which funds for stocks and bonds?

We know now the asset allocation required, and now we will find out about the funds to invest into to make up this allocation.

For equities, I would split them into two. One is for domestic stocks, and it will be the SPDR Straits Times Index ETF. For international exposure, it would be the Vanguard All-World UCITS ETF (VWRD). I would split the equity portion evenly into two.

The reason for selecting the VWRD is that it is domicile in Ireland, and this saves us from paying withholding tax to non-US companies. Another reason is the low expense ratio for the VWRD which will preserve more of our investment capital in the long run.

Although Singapore's GDP is only 0.5% of the world's GDP, I have put in the STI as it provides a currency hedge. I do not want my investments to fluctuate widely simply due to foreign exchange rates movement. VWRD and STI will share a 50-50 holding amongst the equity.

For the bond portion, I would be using the Singapore ABF Bond ETF which is a portfolio of AA rated bonds in Singapore.  This is to provide with the stability in periods where equities underperform and when there is a financial crisis. In these periods, the ABF Bond Index continues to pay us dividends, and protect the fall of our overall portfolio.

Be satisfied with the market returns

Some people have already asked me, "If I hold this portfolio for 20 years, 30 years, what will my returns be?" I would not shy away from answering that I do not know. Past history suggests that stocks will provide around 10% return per annum and bonds around 6%, but this is the past. It might be 1% or 2% in future, or it might be 15% or 16% too. But, we won't know.

So, if this gives low returns, should you go to find other ways of better returns? Finding a fund manager who says he can beat the market? If you can, go ahead, but more often than not, you can't. Countless research have already shown that no one can consistently beat the market. And, the higher the expense ratio, the more money your broker makes, not you.

Remember this quote by Benjamin Graham, "On average, the fund managers cannot beat the average. That itself would be a logical contradiction." So, if you can't beat the average, the best you can do is to minimise costs, and be as close to the average as possible. Hey, being average is good too!

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