The peer pressures of buying a house
I like Ramit Sethi’s blog because it is both entertaining and his free stuff is really of high quality (Which makes you wonder about his paid ones.)
So a recent post of his highlights the invisible scripts that exist within the cultures of most places that buy a house for investment is perhaps the safest form of investing.
In Singapore, we can attest to this. Stocks and bonds investing will always look to be more risky and never get rich scheme compared to real estate.
Sometimes its not that you want to do something because it’s a logical and good idea, but because society forces your hand.
You don’t get married because it’s the right thing to do. You get married so that you don’t have to wait too long for a HDB flat else it gets too expensive.
Reaching 35 years old is a milestone, not because it’s a defining moment in your life, but that as a single you can buy a flat!
There are days where I absolutely admire folks that can do things differently, be it entrepreneurial, choosing a different way to build wealth or having a better goal in life and working towards it.
This video answers a reader’s question whether she should invest in a house. I find that Ramit’s answer generally hinges on property doesn’t appreciate in value past inflation when looking from a long term perspective.
But the same can be said about equities in recent years. Not being able to outperform inflation, doesn’t mean that in the short run, folks cannot profit from it.
The other interesting thought is his consideration of the total cost of ownership. This is something seldom talked about, but would a Singapore flat or condo geared towards being rent suffer a high maintenance expense?
Risk Premium at a high, World stock markets all time highs
Folks will be thinking why after a 4 year market run, we are still getting higher prices. Here is my quick take on it (Spoiler: It looks really bullish)
Equity Risk Premium
The equity risk premium measures the premium required to take on more risk over the risk free rate.
At market highs, the risk premium are usually low because everyone neglects risk and just chase prices. At market lows, risk premium is usually high because everyone is so scared to buy. There is a real premium to earn for the level risk you put in.
This chart shows that current premiums look close to 1975, 1982.
Markets breaking out of new highs
Markets breaking out of new highs above previous psychological levels are very bullish. That, provided that they can stay above for the mean time to reverse it to form support.
Everyone is expecting a triple top. This sort of invalidates it.
I am not one who is focused on technical analysis, but much old school technical analysis folks are pointing that these formation looks like 1982 and 1995.
Note that they are not calling for a straight line move, but the strength of the price movement, even at this stage where things are suppose to weaken is remarkable.
Singapore markets have been in a funk compare to other markets. This chart post recently shows a break out over a multi month consolidation.
QE and the chase for yields
If you scan my dividend stock tracker on all the blue chips and popular yielding stocks, you will see that their yields are approaching a 4-6% range from a 5-8% range.
Yet earnings don’t seem to be following.
Fundamentally, we will say that if earnings don’t substantiate the price rise, these stocks will be overvalued.
That is still valid.
But fundamental valuation requires an important variable: discount rate.
That is based on your required return for the risk you put in.
It used to be the case where gets reset back to the norm as interest rate fluctuates from high to low.
Based on the riskiness of the stock, you may require 8% for the risk you put in, 12% for the risk you put in, 3% for a lower risk stocks.
This QE seems to put a far lower bottom to this. The perspective is that anytime there is a market shock, the FED will go into asset buying, asset reinvestments, loading the market with liquidity.
The safety level or discount factor could have changed so much that 4% is considered the new high yield.
Bond Yields are insignificant, the chase for yield
We know that bond yields are at record lows, and to gain any respectable returns (for major institutions and retail investors), they have no choice to take on more risk.
- Junk bond yields near default grade is trading at 6%
- Folks are looking at Rwanda government bonds.
- High yield corporate bonds are now at government bond yields 10 years ago
The move now is to find a better yielding asset. In this case earnings yield. Thus a strong explanation to this “unsustainable move without earnings increases”
This will end badly, or will it?
The folks will be thinking this is unsustainable and we are near a financial meltdown.
The fear is that we will fall face flat.
The possibility is that decision makers do have a few case study in the past (Ben Bernanke being a student of the great depression) and 2 severe bear market that was unprecedented.
They would have learn if you jerk it hard, a lot of bad things can happen. The fact that their taking their time with keeping things low for so long is that their indicators don’t see things getting better.
Until things get better, there are a few steps that they will need to unwind. For more on this do read The Reformed Broker’s take on this from an investment perspective.
Summary
All this put in, will we get a 20-30% correction? Its possible, but with the flush on everyones balance sheet and infinite QE, that may be hard to happen.
Still it is good to gain that.
But we are still far from the STI 3800 high. And we have not even factor in inflation.
I wonder whether you get more risk in staying in 100% cash in this environment. I guess being vested in a 50% equity allocation make sense here.
The chase for a 6% yield looks difficult so you got to look harder. But if you want lower risk, your best bet could be 4% yielders now.
To get started with dividend investing, start by bookmarking my Dividend Stock Tracker which shows the prevailing yields of blue chip dividend stocks, utilities, REITs updated nightly.
FREE Stock Portfolio Tracker to help track your dividend stocks by transactions to show your total returns.
For my best articles on investing, growing money check out theresources section.
Vanguard’s ETF gains approval to trade in HKSE. Perhaps SGX next?
I got news from Andrew Hallam’s blog that Vanguard, the US investment company has gain approval to trade a selected group of ETFs in HKSE.
This is big because if you would want to form a portfolio of low-cost index ETF, your best bet is to go for the non profit investment management company that’s objective is to minimize costs and create products that benefit investors.
Vanguard was started in the 1970s by John Bogle, well known for being a fierce advocate of passive index investing.
Last year, we covered over here that Vanguard attracted more money than many of its competitors, meaning more are starting to realize the benefits of passive index investing vesus active investing.
No withholding dividend tax
While investors in Singapore can purchase Vanguard ETFs listed in US stock market, the main peeve are currency fluctuations and a 30% withholding tax on dividends.
The withholding tax means that it is unwise to go for a ETF that distributes large amount of dividends such as preference shares ETF, REIT ETF, Utilities ETF, Dividend Aristocrat ETF or High Yield Emerging Markets ETF
The advantage of HKSE is that based on my information and accounts from past readers, there are no withholding tax on dividends.
The downside is that we do not know what ETF will be listed, but I guess it is usually the most common ones which are unlikely to be high dividend based ETF.
SGX a possibility
This gives further support for investors locally to see if they will eventually be listed in SGX.
The main problem is that ETF in Singapore are so illiquid and you may pay a spread premium which wouldn’t be very cost efficient.
The justification to list in Singapore increases when you view the country as a country that is a wealth management hub and high net worth individuals.
Portfolio Rebalancing in individual stock investing
How to carry out rebalancing if you invest in individual stocks to improve your wealth returns with less volatility
I polled my facebook readers on what I have not really covered at Investment Moats and one common question is how I carry out rebalancing.
Specifically, is rebalancing different if you pick stocks instead of a low cost index ETF?
Before we start lets get some things out of the way.
Asset classes mean revert not individual stocks
The main reason why you rebalance is that prices in asset classes (cash, bonds, equities, commodities) swing from overvalued to undervalued due to supply and demand, technology changes, mass psychology.
If you have determine a 60% stocks and 40% bonds allocation based on your risk adverse nature, markets will swing up and down and that allocation will change.
If you do not bring it back to parity, your portfolio may be overly risky or conservative.
One thing to note we are talking about asset classes as a whole.
When you invest in individual stocks, Its different. Your stock can go to zero, but as an asset class, equities cannot go to zero.
Invest in individual stocks versus equity funds
The main reason you will invest in individual stocks is that you can control your costs as oppose to expensive mutual funds / unit trust, but also that you think you are better at selecting better stocks than the market (index)
You believe you can outperform an index.
That is why you do not rebalance based on individual stocks. That somewhat counteract the reason you invest in individual stocks.
Rebalance by asset class correlations
The reason why it’s a demarcation between stocks, bonds and cash is because they are classified as asset classes that are uncorrelated.
Different bonds will have their own individual risks, but will also have risks that all bonds share such as interest rate risk that have a greater profound effect compare to individual bonds.
Similarly, your stocks may be govern by the profitability of their business in the next 10 years, but they are affected by systematic events that affect equities as a whole.
Do factor in to rebalance different groups of assets that have different correlations.
It is usually stocks and bonds because when stocks do well, bonds do not. When commodities do well, cash gets eaten by inflation.
But on a long term, the asset class must go up to make this meaningful to invest in. If not what is the point of investing at all.
Discipline way for buying low and selling high
As with equity funds, periodically you will review if you portfolio have veered out of the x% stocks, y% bonds, z% cash allocation.
An outperformance in one group means that the market that there is increase chances of a mean reversion of that asset class on the horizon.
Rebalancing by selling, or under-allocating means a discipline way of selling high.
When there is an abundant build up of cash, it means you may be overly conservative and not taking enough risk. Rebalancing by buying more bonds or equities brings the portfolio back to the desired allocation.
Step 1: Determine your asset allocation
The first step is to determine your percentage to allocate to for each asset allocation.
Each asset classes can have different rewards versus their risk, which in portfolio talk, means volatility.
Know your risk tolerance
As an investor, you have different tolerance to this volatility. You may not know what is your tolerance but it matters a lot.
Some folks (including me) thought they can stomach a 50% fall in net worth easily. The great financial crisis make them see the reality of it. They sell out at a low and refuse to buy at the low.
- Stocks: High returns but subjected to +/- 40% movements in the short run.
- Cash: Low returns but very very low volatility.
- Bonds: Medium returns and subject to +/- 20% movements in the short run.
Asset allocation changes
The level of volatility you can take varies when life changes. When your portfolio is small and perhaps when you are young you can take more risks so you can go for a 70% stocks, 30% cash allocation.
But when you are 60 years old, I don’t think you will want that allocation. You need the money soon and an impairment of 50% to your net worth can put a lot of cash flow problems on your shoulders.
Drizzt
For myself, the great financial crisis have thought me much about my risk tolerance. That I overestimate it.
While concentrating picking individual stocks, I neglect to see the benefits of certain asset classes like preference shares, and bonds, how their lower volatility can compliment my risk adverse nature.
At my age the asset allocation should be a 70% stocks 30% bonds allocation if I am using a unit trust or ETF. I am more risk adverse, so I should favor a 60% stocks, 40% bonds allocation.
But if you are picking stocks, liquidity is important and that is where having cash is good. Cash is like a call option that you can exercise in market downturns to purchase individual stocks or equities on the cheap.
If I were to favor a stock and cash portfolio, I will lean towards a 70% stocks, 30% cash mix. More stocks to take more risk since cash have lower returns than bonds.
Yet have enough to rebalance in a market down turn.
Step 2: Adding additional funds to your portfolio
As working people, we are determined to “Pay yourself first”. That is why you funnel X amount of your disposable income to “Wealth Building”.
So if you funnel $1500 in monthly, add that to your cash asset allocation.
Assuming your allocation is 70% stocks, 30% cash, the current market can mean that the value of your allocation (note value not cost) becomes 85% stocks, 15% cash.
Based on your allocation, you should be raising cash. Thus the easy decision is to bank in the $1500 into your cash asset allocation, to build it back to 30%.
Intuitively, it means “prices may not be as cheap as it is used to, I am being discipline and not buying at a high.”
In a market downturn, the allocation becomes 40% stocks, 60% cash, mostly due to your stocks losing a massive chunk of value, your $1500 will go to picking undervalue individual stocks.
Initiatively, it means “price have been beaten down and if I buy now, I am buying low”
Step 3: Buying Selling securities in your asset classes
The decision to buy and sell the underlying securities should be taken based on your evaluation of whether it measures up to your original expectation of the investment.
It is an entirely different matter all together from portfolio management, which we discuss more here.
If you have a Starhub or Berkshire Hathaway, that is maintaining its edge, and you do not see a reason to sell, then just let it run.
If you spot a good bond that yields 8% but the risk is lower than market expected and priced well, you can choose to buy it.
Just so you know that you may veered off your targeted allocation of 60% stocks, 20% bonds, 20% cash for example.
You then may want to look at each securities individually, which is least appealing, which you have made a wrong move but still earning and you may want to replace it with this more appealing investment.
Step 4: Review your asset allocation mix
The investment world changes such that there may be a viable alternative asset class that can boost your portfolio and at the same time lower its volatility.
This can be private equity, traded endowments, variable annuity, timber, business trusts.
Periodically, preferably quarterly do a re-evaluation whether you can better align your wealth portfolio to your risk adverse nature and your life goals.
Summary
I think there are no hard and fast rule to which asset allocation is the best. Although, for me, asset allocation is more important than individual stock selection.
Right now I am under invested. I would have handily do much better if I don’t pick stocks and just lump, 30% from cash to deploy in an STI ETF or Vanguard World Stock Market ETF. That more or less aligns to my financial goals rather than vex about the risk of individual companies.
In this case I missed out on the bigger picture while nit picking on small things.
Thus my view is that having the right allocation mix at the right time is more important than the individual asset securities selection.