We often get questions from readers on various topics about personal finance. While we are not always able to answer all of them, we try our best to answer as many as we possibly can, especially if we think there may be others out there with similar questions in mind.
For this week, we will answer two questions relating to investing.
Question 1: I want to park my excess cash into an account or buy unit trusts. I prefer not to spend $500 a month on credit cards just to earn interest from saving accounts. Are unit trusts safe? Which are the best ones?
The answer to this question basically boils down to a simple concept. Risk vs Return.
Our reader wants higher return, compared to earning a paltry 2 to 3% per annum from his savings account. However, we must always remember that in order to expect higher return, one must be willing to take on greater risk. This is a simple financial concept known as the risk/return tradeoff.
A common question asked at this point would be how investors can reduce risk without sacrificing expected returns. There are a few methods of doing so.
One such way is through diversification. By investing into different stocks, bonds and other financial instruments, an investor can expect similar returns while reducing his or her risk exposure.
For example, if you buy into just one telco company (e.g. StarHub), with all telcos being equal, you should expect similar returns to what you will get if you invested into SingTel and M1, or a combination of them.
However, common sense would suggest that while expected returns remain similar, it’s safer from an investment point of view to be investing in all three telcos (assuming all telcos being equal) rather than to choose only one of them.
That’s the same approach that unit trust managers (as known as fund managers) take. They try reducing risk by investing into a pool of high quality companies and sectors.
Fund manager typically try to outperform the market. For example, if the STI delivers a return of 5% in a year, a fund manager would aim to generate higher returns through active management of their portfolio. In other words, they buy stocks they think would do better and sell stocks that they think will not perform well.
Unit trusts, like all investments, carry with them an element of risk. If the stock market performs poorly, the value of their portfolio would also drop.
It’s hard, if not impossible, to say which are the best unit trusts. Would a unit trust that delivers an 8% return through investing in growth stocks in China be considered better than another unit trust than generates 5% return through investing in stable blue chip stocks? Not necessarily.
Invest In What You Are Confident About
You need to invest in unit trusts that are exposed in countries and industries that you are confident of. That confidence should come through knowledge and experience of the investment sector(s), rather than through blind faith, rumors, or based on what has happened in the past.
A good unit trust manager can help better identify the best companies within the investment sector that you are looking at in the hopes of generating a higher return than what the market would provide.
Question 2: I want to save $2,000 every month. What can I do to best grow my savings?
The simple answer will be to invest.
However, what you invest in really depends on what you are saving for, or, as we prefer to call it, what your financial objectives are.
For example, if the intention to save $2,000 a month is to work towards an early retirement, then it would make sense for some of the money to be used to top up one’s CPF account, since the CPF Special Account generate a risk-free interest of 4 to 5% per annum.
If your intention to save $2,000 a month is so that you can buy an investment property in the future, investing the money in the stock market would help you grow your money quicker, especially if you are looking at a 7 to 10 year timeline.
If your intention to save is for your wedding or an upcoming home renovation, then the money you saved should be put into low risk asset classes such as government bonds (i.e. Singapore Saving Bonds) or bonds issued by high quality companies.
If you want to enjoy passive income from your investment, then you can consider investing your savings into asset classes such as Real Estate Investment Trusts (REITs) or even the STI ETF, which gives annual dividends of about 3%.
Of course, it’s possible for your investments to be made in a variety of the above mentioned asset classes. Just remember that how you invest your savings depends on what your financial objectives ultimately are.
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