Building a newbie portfolio

So someone asked me for help to build a portfolio. Our hypothetical investor wants to start with an initial investment of $3000, and a regular monthly contribution of $300, and not a whole lot besides that. Because the investor doesn’t have a whole lot of investment knowledge, they aren’t afraid to ask important questions that aren’t easily answered, such as:

‘So how much can I lose?’

‘Who am I investing with?’

‘What am I investing in?’

‘How much can I get out of this?’

‘How long will it take?’

‘Can I trust you?’

I do like big butts.

In other words, all very good questions that many salespeople will finesse their way through without giving you a straight answer. The reason for this pervasive evasive is somewhat nefarious, and not entirely relevant to for the purpose of this post, but suffice to note, these are all important questions that should be asked for all investments.

While the answers are important, so are the logic and assumptions behind the answers. After all, Bernie Madoff could easily answer any of the above six questions without breaking a sweat or, apparently, making an investment (link leads to an interview with Madoff, it’s pretty illuminating).

And regardless of what the recent crop of Sunday Times stories about young investor profiles will tell you, not everyone has the upper income parents/ financial advisor background/(very) high risk appetite/ $50k from parents/multi-industry business owner parents/multiple bank accounts and credit cards/ modeling career/frugal thrift to start off with a $20k portfolios. Personally, I question the message the Sunday Times investor profiles is sending. Advertisers should really find a better place for their ads. I’ve always admired the sports correspondents at TNP.

Back to the matter at hand; a starting amount of $3000 and a monthly contribution of $300, and about 40 years to play with till 65. Let’s also be really conservative and assume a nominal return of 3% p.a.

Say the investor retires at 65, and lives to a ripe age of 80.

Assuming all the above, we’re looking at a monthly income of around $4000 until 80 rolls along and our hypothetical investor dies gracefully. A couple of things I don’t know how to account for are inflation and the time value of money, but I’ll just leave that for now.

Peaking at around $743k, the question is then how can we achieve that 3% p.a. over a long period of 40 years. With only $3000, we’re looking at around one or two funds at best.

With that cap on options, I’m thinking of a half and half equity-bond mix. Given that bonds have had a terrific run over 2007 to 2012, I’m willing to take a little more risk on equity exposure right now. But for the sake of my sanity, I’ll go with the textbook 60/40 mix between equity and bonds.

To represent equity, I’m using the MSCI AC World TR, and for bonds, I’m looking at the Barclays Multiverse TR USD Unhedged, both in SGD terms. Drawing on 9.5 years of data (no real reason for that number, its entirely arbitrary), you see a good range of 12-month returns.

Based on the chart, one has a rough idea of how much one can win, lose and expect over a 12-mth period. This settles a good number of the above questions, with exception of ‘Who am I investing with?’

Suicide by statistics

A recent report titled ‘suicides hit all-time highs in Singapore’ first broke on the AFP, and subsequently got picked up by Bangkok Post, Yahoo! News Singapore, and even Fox news.

With all this attention, I wouldn’t fault someone for thinking that life in the land of eternal sunshine is a weary façade for depressed souls trying to claw their way out of Singapore Inc. 

Foolish Singaporeans, there is no escape!

It’s a catchy headline, I can’t fault them for that, but out of curiosity, I went looking for the dataset from the Samaritans of Singapore, and the claims are entirely true:

Suicides in Singapore hit an all-time high of 487 in 2012 as more young people bogged down by stress and relationship woes took their own lives, a charity group dealing with the problem said Friday.

The tally, a 29 percent increase from the 2011 total, was boosted by an 80 percent rise in the 20-29 age bracket, the Samaritans of Singapore (SOS) said in a statement. (Link)

But what feels a little lacking is some perspective. 

After all, a one year 29% increase in suicides does not a trend make. Drawing up the data showed the absolute number of suicides was indeed at all-time highs, but given a larger population to begin with, it doesn't seem entirely alarming.

I should probably point out that suicide through the lens of data and statistics is not the same as drilling down to the experience of each individual. The question I’m asking is not about the individual, it’s about the population as a whole, and every individual’s case is uniquely tragic.

But overall, society seems to be doing fairly all right.

Sources:

Total suicides, Source: Registry of Births and Deaths, Immigration and Checkpoints Authority, Singapore. Last accessed: http://www.samaritans.org.sg/National-Statistics.pdf

Population: Extracted from www.singstat.gov.sg

From a different angle, if total number of suicides is expressed as a percentage of total population, it still looks fairly stable.

Sources:

Total suicides, Source: Registry of Births and Deaths, Immigration and Checkpoints Authority, Singapore. Last accessed: http://www.samaritans.org.sg/National-Statistics.pdf

Population: Extracted from www.singstat.gov.sg

Now, if we were to compare suicides with total death rate, the picture shifts slightly.

Sources:

Death rate: CIA World Factbook

Total suicides: Source: Registry of Births and Deaths, Immigration and Checkpoints Authority, Singapore. Last accessed: http://www.samaritans.org.sg/National-Statistics.pdf

Population: Extracted from www.singstat.gov.sg

Things might look quite alarming, if not for the fact that while suicides are at all-time highs, death rates are at all-time lows: 3.41 deaths per 1000 population, according to the CIA World Factbook.

So the question becomes: why don't the all-time low death rates make headlines?

Numbers on a page

I’m generally wary of writing about data.

Numbers are a different language from words, the former developed primarily for quantifying, measuring and, in my case, stultifying.

Words on the other hand, being the general-purpose tool evolved over lifetimes of use and abuse, have the unenviable task of deal with the amorphous category of the immeasurable.

So while I can throw data on to a blank page, it generally looks much prettier when vomited onto a chart.

That's quite a lot of money.

The chart shows the growth of 60k, with an annual 12k investment, compounded at 8% per annum, will grow to roughly 2.2m in 30 years. The key question in this case is to find an investment that can reasonably be expected to compound reliably at 8% yearly for 30 years.

I’ve been told early-stage Ponzi schemes make excellent investments, but they seem to be in short supply.

Eat thine own cooking

I would have written this a long time ago, if my motivation wasn’t so readily eroded by distractions and general inertia.

Say you have about S$100,000 to invest, and in 10 years, you want to grow it to S$1,000,000. The actual numbers are unimportant, but the point is the compounded growth rate needed to achieve that goal. To get there in 10 years, you would need to grow that S$100,000 by around 26% every year, for 10 years.

When I was 20, I thought I’d be a millionaire by 30, and retire by 40 to live by the beach and surf and dive all day; and I thought 26% compounded over 10 years was a realistic rate of return. Ah, youth.

Merlyn Ee of the MAS was recently quoted saying, ‘We need to do more to help Singaporeans better prepare for life's unexpected events and to set aside adequate savings for their golden years.’ And citing a HSBC survey done,

Over half of Singapore respondents feel their financial preparations for a comfortable retirement are inadequate: 44% feel their preparations are not enough, whilst 12% are not preparing at all.

She does have rather lofty aspirations for financial advisors in Singapore:

Financial advisory firms can help Singaporeans realise these goals. My vision for the financial advisory industry in Singapore is for financial advisers to be viewed as professionals, just like lawyers, engineers and accountants, with their own code of conduct and high standards of practice.  We are not there yet.

With the exception of the last sentence, real reform lies in a more informed group of consumers, who won’t end up buying structured products, neglecting their investments, and falling for sales tactics practiced by some in the industry. The tricky bit is finance isn’t something people think about a lot. Sure those of us in the industry spend quite some time on it, but I would wager a good number of us, myself included, have quite a few blind spots when it comes to the financial 

phantasmagoria of products.

I can think of two reasons why. Firstly, many don’t have a foundation in finance. I certainly didn’t study finance. What I know has been gleaned over years of experience and a hodge-podge of financial literature often written for larger markets. I’d like to think I know the basic tents of investing but that leads to my second point; knowing versus doing.

This doesn’t get talked about enough. Doing finance is a bit like doing a budget. It sounds and feels good talking about it, but actually sitting down and itemizing income and expenditure ranks somewhere below watching grass grow. Picking investments is the fun part, like shopping for nerds. Portfolio maintenance, rebalancing, and creating excel models is the boring stuff.

If finance is going to be a bigger part of Singapore’s economy, it’s peculiar that not much emphasis is placed on the financial skills needed to make sense of the discipline, especially in schools. 

Some might say it’s a responsibility.