There’s been a lot of buzz about investing going around lately, but it’s hard to know where to begin.
How do you invest with little capital, for instance? Should you go for a high growth strategy or passive income? What sort of traps should new investors avoid?
Today, we’ll cover five foundational aspects to investments for beginners:
- Setting goals and understanding your current cash flow
- Starting early and investing consistently
- Diversifying your portfolio
- Accounting for market volatility
- Watching out for taxes, fees, and commissions
Tip 1: Set Goals and Understand Your Current Cash Flow
Becoming a successful investor begins with a plan. Think about why you’re investing, then come up with a concrete and realistic goal to hit.
An Example of a Goal & Simple Action Plan
Let’s say you want $27,000 in five years so you can pay off your student loan. This goal then informs how much you’ll need to save and invest per month.
The average returns for the S&P 500 (a US market index) have been 10-11% per year. Going by the more conservative number of 8% annual returns, that means you’ll need to invest about $4,300 per year to hit $27,000 in five years’ time.
Assuming you get paid monthly (or get a monthly allowance), you’ll have to save at least $358.33 of your income every month.
If that doesn’t sound doable, you either have to adjust your goal or find ways to optimise your savings rate. We talk more about savings rates here, but in short: your savings rate is the biggest determiner to how fast you’ll reach your financial goals.
Remember: the market rewards the patient and diligent. Investing isn’t a “get rich quick” scheme. If you’re expecting $1,000/mo in passive income in 10 years but can only invest $200 each month, you’d have to achieve ridiculous returns of 267% every year to reach that goal. Even famed investors such as Warren Buffett mentioned that annual returns of over 12% is purely luck.
Tip 2: Start Early and Invest Consistently
We all know about the power of compound interest, which is why many people are injecting money into high savings accounts at regular intervals. This concept also applies to investing but with one extra benefit: you get to lower your risk.
One strategy that takes advantage of this is called Dollar Cost Averaging (DCA). It’s popular amongst new investors as you don’t need to continually manage your assets. All you need to do is to put money each month into a vehicle like Regular Savings Plans (RSPs).
“Buy and Hold”
When you adopt DCA, you’re usually looking at investing for a long time horizon — at least 10-20 years. That means you won’t be able to use those funds for quite a while.
The longer you hold your assets, the more time they’ll have to weather the ups and downs of the market and generate good returns for you. You won’t fall prey to FOMO or to panic selling, and you’ll avoid the trap of timing the market.
Tip 3: Diversify Your Portfolio
Ever heard the saying, Don’t put your eggs in one basket? This applies to investing too!
Investing isn’t about gambling it all on whatever’s hot and hoping it skyrockets. As a new investor, aim to minimise the overall risk and volatility of your portfolio so you can retain the most profits. To do so, you’ll need to diversify your portfolio with various asset types to average out your returns.
Stock picking can be challenging even for seasoned investors. While we recommend learning about the different methods to analyse the underlying businesses, it’s usually better for new investors to buy index funds instead of individual stocks.
When you’re younger, you can take on more aggressive strategies as you have less to lose and a longer runway. But as you get older, you’ll want to switch to a more stable, income-generating portfolio to fund your retirement years.
This ratio helps investors determine what percentage of their assets should be in equities and what percentage in bonds.
Formula: 120 – your age = equity % (put the remaining portion in bonds)
For example: If you’re 30 years old, then 120 – 30 = 90% of your portfolio should be in equities. The remaining 10% will be in bonds.
This isn’t a one-size-fits-all approach. As you age, you may decide to invest almost wholly in bonds and dividend stocks. More risk-averse investors can also use 100 instead of 120 in the formula above.
Tip 4: Account for Market Volatility
In layman’s terms, market volatility refers to the up and downward price spikes in a given timeframe. If you see an asset’s price zigzagging rapidly in a short span of time, that asset has high volatility. In contrast, an asset with low volatility has more stable — maybe even boring — price movement.
Something with high volatility can be exciting for investors at first. Just take Bitcoin, which spiked from US$13,967 in September 2020 to US$53,916 in just six months.
But volatility also means it can go the other way: after peaking at about US$63,500, Bitcoin dropped close to US$30,000 three months later.
Volatility isn’t necessarily bad though. In fact, market volatility is a normal part of long-term investing, and most portfolios include a mix of both high and low volatility assets.
If you’re counting on withdrawing a chunk of your portfolio in the next few years (e.g. to buy a house), it’s best to go with a larger percentage of lower volatility assets that you can easily liquidate. But if you can afford to leave your funds to grow for the long term, higher volatility stocks may provide much better returns.
Tip 5: Be Aware of Taxes, Fees, and Commissions
Sadly, there’s no free lunch in this world. Despite all the brokerages touting low or no commissions, in reality there’s no such thing as completely commission-free trading.
Pay attention to the platform, trading, management, and commission fees you may incur. In most cases, every time you trade a stock, you’ll be charged a commission on top of platform fees. These fees will affect the overall returns you get, especially if you have low capital.
Taxes are another charge that will eat away at your returns. Singapore generally has favourable tax laws for investors: you won’t have to pay a tax on your capital gains. But if for example you venture into the US market, keep in mind that the US will withhold 30% of your dividend income since Singapore doesn’t have a tax treaty with the US.
Taking the Next Step into Investing
It’s easy to feel intimidated with all the things you have to learn as a new investor. But if you’re just starting out, there are many options to help you keep your risks low — robo-advisors, RSPs, insurance savings plans, Singapore Savings Bonds, and so on.
Before transitioning into an active investor, we’d suggest going with a DCA or passive investing strategy. This would help you gain some confidence and experience with the markets.
Along the way, it’s great practice to look up educational materials to help you build up your knowledge of market analysis in your quest towards greater portfolio returns.