Before you start investing

You should know your investment objectives, net worth and risk profile.

Wed, Apr 06, 2011
The Business Times

By Teh Shi Ning

IT is a truth widely acknowledged that a single man in possession of a good fortune must be in want of a good investment to marry that fortune to.

These days that single man, or woman, is likely to be younger, and typically hoping his investments will make his fortune good.

One reflection of rising investor interest among the young has been the Singapore Exchange lowering the minimum age to open a trading account to 18 two years ago, but the number of savvy young investors and success stories of their ilk appear to be on the rise too.

Interestingly, people often embark on financial planning and investing later than they think is ideal.

While based on the rather dated National Financial Literacy Survey of 2005, 54 per cent of those surveyed thought they should start planning their finances once they start work, but only 32 per cent actually did. This does still seem to be the case.

Most would appreciate the importance of investing, over and above saving, especially in this current low-interest rate environment. But many are also daunted by the sheer array of investment products and opportunities out there.

To warm up for the plunge into these asset classes next week, here are a few points to think through before you start investing, or for those already dabbling in investments, to take stock of where you are headed.

What are your investment objectives? What is your investment horizon?

Investment objectives are set by balancing your current and future financial needs.

Youth is on the investor's side. Each person's investment objectives are shaped by the stage of the life-cycle he or she is at, says Ang Ser-Keng, senior lecturer of finance at the Singapore Management University's Lee Kong Chian School of Business.

'The investment objective is important because it affects the time horizon,' says Mr Ang. So, a young person who has by default a longer expected life span, can afford to view his investments over a longer time horizon and thus take on riskier investments in exchange for potentially higher returns.

But people in their 20s would range from those still in tertiary education, to fresh entrants to the workforce, to others who may need to factor in support for ageing parents. So, age is not the sole determinant - lifestyles and personal financial commitments shape investment goals too.

Other points to consider include whether big-ticket expenses such as a wedding, a car or a house are on the cards, and whether you intend to save for and finance your children's university education.

Will upkeep of a certain lifestyle retirement suffice, or do you aim to attain spectacular investment success Warren Buffett-style (and give most of it away)? Why you intend to amass wealth will help determine where you decide to put your money into and how.

What is your financial situation/ net worth?

It's also worth having a clear idea of how monthly income and expenses affect how much you can invest.

Mr Ang says a simple gauge of how much you are able to put to work in the markets is to figure out your (Keynesian) money demand in transactionary, precautionary and speculative terms.

In other words, cash for day-to-day needs, cash for the rainy day and cash available to invest and grow.

Invest only with money you can comfortably spare both now and in the foreseeable future, he says.

'It also does not hold you hostage to having to sell assets at very low prices under adverse market conditions, very frequent these days, so that you can sleep well at night.'

What is your risk profile?

Most people can instinctively say if they have a good appetite for risk, or a tendency to shy away from risks. But that is only a subjective type of risk profiling.

'It is a common myth that a risk profile is just about how much risk an investor is willing to take - risk taking versus risk aversion,' Mr Ang says.

If a risk profile is to be used in asset allocation, it needs to be supplemented with an objective risk profiling. In other words, not just how much risk you think you can take, but how much you can actually afford to take.

'The litmus test of an investor's capacity to take risk is whether he would suffer a significant loss in quality of life if a complete loss of the investment occurs,' Mr Ang says. If so, he should then view himself as owning a lower risk profile, even if behaviourally, he is a risk taker.

How much do you know about investing?

'An investment in knowledge always pays the best interest,' Benjamin Franklin once said, a phrase just as well applied to investing for financial gain.

While money management is a lot of common sense, investing entails products and strategies that are not always easy to understand.

On top of researching thoroughly any investment product or strategy, the basic rule which bears repeating, going by the fallout post-Lehman's collapse, is to ask till you understand, and if you still don't, avoid.

Some oft-mentioned strategies include:

Diversification and asset allocation

Spreading the wealth you wish to invest across a variety of investments helps reduce the risk that the failure of any single investment wipes out the value of your entire portfolio.

Different products react differently to the shocks which rock world markets more frequently these days, and diversification can be undertaken by asset classes but also by sectors and geographies.

Think about the composition of your portfolio methodically. The mix of assets in your portfolio ought to help reduce your overall risk, while the exact allocation depends on your investment horizon and risk tolerance.

Dollar-cost averaging

Some advocate invest set amounts on a regular basis over a certain time horizon, whichever way the market heads, as a useful way to invest amid volatility. The idea behind this is that since investors are unlikely to be able to 'buy low and sell high' or 'time the market' all the time, it is preferable to buy a smaller amount each time but do so regularly.

While no shield against market fluctuations, dollar-cost averaging is supposed to lower the average cost of investments over time compared to that of a one-off investment. This is because, in theory, regular investing will mean buying more shares when prices are low and fewer shares when prices are high.