Here is why you need and how you can invest

6 things you should know before you invest


This blog post is for you, to convince someone why and how they need to start investing. Regardless of the person being your children, spouse, or parents, I wish for this post to be useful to you and to them.

And, I will keep this post updated and add more research once I have them. Content that will be covered in this post include:

  • Inflation
  • Index investing
  • Long run performance
  • Optimism in investing
  • Value versus growth debate
  • Expense ratio

You will, hopefully, become more knowledgeable. Optimistically, your children, spouse or parents, will start to invest. Use this post whenever you need to convince somehow to take up investing.

Inflation

The main reason why you need to invest is because of inflation. In Singapore, we are fortunate that inflation rates are relatively low at around 2% for the past 10 years. If you don't know inflation, just think of how a plate of chicken rice increased from $2 a plate to $3 a plate.

If you put your money in the bank, you are effectively losing money. The current rate offered by Singapore banks are around less than 1%. Anything less than the inflation rate means that your money is being eaten away.

Index investing

When people talk about investing, there usually talk about individual shares or stocks. People get all excited when their shares increase in price. If the stock they bought went down, they usually find that investing is dangerous and then never invest again.

However, that is not how investing is supposed to work. Buying an individual share is risky, because you can potentially lose all your money. Instead, you should diversify. The more stocks you hold, the better you are, because the lesser risk you will carry.

The best way to do it? Buy an index fund that contains all the stocks in the world. Yes, you heard that right, buy every stock that is out there.

Long run performance

If you hold your stocks for a long period of time, expect to get a return of around 5% above the risk-free rate or inflation rate. In other words, you will have a real return of 5%.

What if you hold your stocks for a shorter period of time? Then, you can potentially get higher returns or, greater losses. So, diversify not only through number of stocks, but also through time as well. If possible, hold it till forever.

Optimism in investing

Forget market timing. As an index investor, you must believe that "time in the market is more important than timing the market".

Peter Lynch is a legendary investor and fund manager of the Fidelity Magellan Fund from 1977 to 1990. During his tenure, the annual return of the fund was 29%. Given that, you would have expected investors in his fund to make enormous returns during this period. However, the average investor actually lost money.

The reason comes from investor's optimism and pessimism, leading them to trade too often. The best strategy would be to practice dollar cost averaging, and invest a fixed amount of money into your index fund automatically and systematically, regardless of emotion.

Value versus growth debate

So, apparently some people debate about value and growth. Studies have been done that proved that value outperforms growth. Value stocks are defined as stocks with low price-to-book ratios, while growth stocks are defined as stocks with high price-to-earnings ratio.

However, did you also know that growth stocks outperform value stocks too? Well, it depends on the time frame you are looking at. What I can suggest is to ignore this selection, as well as other such anomalies, because you would never know what the future would be.

Instead, buy an index fund that is representative of the entire world, giving no extra weight to any particular sector or industry.

Expense ratio

Now that you know that you have to get a fund that contains as much as possible of the world's listed equities, the next thing you need to be aware of is fees. Fees eat into your returns, a 1% difference in annual fees can do your investments a lot of damage.

A gross return of 7% over 30 years turns your $10,000 initial investment into $76,122. Include a 1% annual fee and your total returns drop drastically to $57,434, a 25% drop. Even a 0.1% difference is harmful, giving a total return of $74,016, a drop of 2.8%. Fees matter, all else being equal, get the fund with a lower expense ratio.

In summary

You have got to invest because you are losing money by putting them in the bank. Forget about picking individuals shares, and go for a wholly diversified portfolio of stocks by investing in an international index fund.

All else being equal, get the fund with the lower expense ratio and initial sales charge. Don't follow the hype, but rather invest systematically, and hold it for as long as possible. Investing is risky, but with this knowledge, you will reap great returns.

For more information, check out these posts:
The simplest (and probably most proper) way to passive investing
What is the Boglehead Singapore 3-fund portfolio


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