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?’