Thursday, June 26, 2014

Much Ado about Wealth-Building

Dear Gerald,

I must first of all confess to you that even as I write, I'm filled with scepticism on how this correspondence will go. So am seeking advanced forgiveness for any sort of offence I may unwittingly create, and I also seek your patience in reading this email.

I am a 9-to-5 desk bound office worker. Through years of being with the same company, I've managed to earn my seniority and experience in dealing with international environmental agreements. I am happy with my wage - After all, I'm duly employed and these days in this unpredictable climate, it is a situation that I'm very grateful for, being gainfully employed, that is. 

But everyday there is something nagging at me to do something to increase my resilience to the changing world where everything seems to get more costly and so quickly, and where, quite frankly, money helps to take the discomfort out of our lives where necessary. I'm not trained in any sort of financial discipline, nor have I ever had any mentor whom I could approach, but I see the need for me to start thinking seriously about embarking on building up my savings and eventually being able to call it wealth. 

I know next to nothing about investment and I've just ordered a book to start off my awareness of it. But as with most books, I think it all but gives very little details about doing the right homework and research. To my naive mind, I hold an instinctive belief that as with all things in life, we need preparation and this requires doing tons of homework just to make one right move - or at least one that mitigates the most risks. The point is - I don't know how to do such homework. I try to understand the financial jargon that I see in publications and newspaper articles but that mind of mine is struggling with the technical stuff. 

I've followed your blog posts every now and then and each time I wish I could make such analyses. I often wondered how folks learn. With this email, 'm hoping that you Sir, could help to guide me to the proper direction on how I can get started on investing in shares, bonds, bullion, etc. I already have some insurance plans that have an element of investment but those were made by my father years ago and I truly don't think they are being properly managed. I would prefer to learn about the market dynamics on my own so that I can study the trends and developments with a more in-depth and learned understanding. At least when I make a wrong move, I can blame only myself. And understanding how things work intrigues me quite a bit. 

Apologies if I've been too audacious in making such a request in this email to you. My intention is only to try to learn to do the right thing for myself. If you wish to have no further contact with me, please let me know and I will pursue this no further. 

Thank you.

Yours sincerely
_________________________________________________________________________________
I received the above letter from one of my readers a couple of weeks ago and felt obligated to reply to her. Firstly, I am not a licensed financial planner, so I must clarify that I am not providing any form of advice. The articles in this blog reflected solely my views and opinions on the investment scene in Singapore. In this regard, I would not bear any monetary losses arising from any investment instruments written in these articles. 

To be a successful wealth builder, you need to understand the concept of risk and returns before you start to invest. In the email, the reader did not share with me her age or financial profiles but I reckon that she should be in her forties. Usually, as an investor grows older, his/her risk tolerance should decrease due to the shorter investment time horizon. Of course, age is subjective to everyone and there are financial bloggers in their fifties who build their investment portfolio solely on shares, which I have much misgivings because of the higher risks involved. To me, if I am in my forties or fifties, my risk tolerance would be moderate and I would limit my shares holdings in my portfolio to not more than 50%. I would diversify the rest of my investments in SGS bonds, bullion, cash and property. In Singapore, not many investors practise risk management and diversification because they are more interested in making quick monies from stock investments.

So what are shares to invest in if you are new to the scene? The key is to invest within your circle of competency. This means that if you work in an industry or trade for a period of time, your trade knowledge and competence should enable you to know the developments in the industry. For example, as I work in the aviation sector for many years, I know which local aviation stocks to invest in and which are the loss-making stocks to avoid. Given a choice, I would invest in SIA Engineering rather than Singapore Airlines. This is because the former's core business is in maintenance works for local and foreign carriers and maintenance works are fundamentally recurring business, so the revenue would be very stable once you secured fixed term contracts from the airlines. On the other hand, Singapore Airlines' business is in the provision of flight services, which is cyclical in nature and subjected to fierce competition from low cost carriers and regional players like Emirates and Qantas Airways. So my point is, since the reader works in the environmental industry, she should have a good grasp of how the local environmental business scene is like. For example, she should make use of her subject matter expertise and determine which are the better waster-water companies or environmental control companies listed in SGX to invest in.

So how do you do your research on local shares? Most companies publish their annual reports for the past 5 years in their company websites. Usually, I would download these annual reports to gauge the company's business and financial performances. Alternatively, the annual reports can be downloaded from the SGX website. It is best to avoid tips from brokers or forums. Many financial bloggers also wrote articles on which companies they invested in. My advice is not to follow blindly and to do the due diligence before investing. For new investors, reading the annual reports can be quite overwhelming, especially if you are not financially trained. But my view is that all the meaning of the financial terms in the reports and their significances can be found in the internet, so investors should spend some time to understand them and build up their foundations. There is really no short-cut. You certainly need to be an accountant to compile the annual report but you don't have to be an accountant to understand the annual report. For me, after reading annual reports for 15 years, I can determine which are the important numbers to look out for within 15 minutes. 

When I evaluate a company's annual report, I would look out for the Return on Equity (ROE), Net Current Assets, Long Term Debts, Net Cash from Operating Activities and Dividends declared for the past 5 years. These are the financial aspects which are useful to gauge the company's performance and valuation. For me, I place higher emphasize on ROE than Earning Per Share (EPS). Of course, it is a given that the company should be making profits but ROE would give you how efficient the company is generating profits with the money that shareholders invested in. A good company should be delivering ROE above 10-15% per annum for the past 5 years. When it comes to reporting profits, there are several accounting tricks which may lead the investors into thinking that the company is doing pretty well. For example, a company may sold one off one of its business subsidiaries and declare the proceedings as a form of profits for that quarter. When this happens, a discerning investor would immediately raise a red flag and check the rationale for the sale of the business unit. In addition, to gauge a company's corporate health, it is important to note their net current assets, net cash from operating activities and debts.

So when do you buy a stock?  This would entail a process of valuing the company. Determining the intrinsic value of a company is both an art and science and it is something I am still learning. Besides doing quantitative analysis on the companies through their annual reports, it is important to do qualitative analysis as well. For example, you need to know the industry operatives, business models, their products and management execution. My opinion is to invest only in companies with products or services that you can understand easily. For example, many local finance bloggers invest in REITs, something which I have never dabble in because of my lack of knowledge on the business model of REITs. Many investors thought that they know about REITS business model and invested in them solely because of the attractive yields. Yet, during the 2008 financial crisis, many REITs investors were shocked to find that these REITS were actually heavily leveraged and many Asian REITs faced debt refinancing issues during that dark period. In fact, in October 2008, New City Residence Investment filed for bankruptcy, the first listed REIT to fail since Japan's REIT market was created in 2001.

The last topic I would like to share with the reader is on getting the right insurance coverage. I am not an insurance planner, but usually I encourage my readers to buy health and term insurance policies only. This is important because insurance is a form of wealth protection to cover you when you lost your ability to earn active income. So you should buy term and invest the rest. Many investors tend to view insurance as a form of investment and expect certain rate of returns of between 3-5% to beat inflation in Singapore. But in my view, this is not what insurances are meant to be. We insure ourselves against the risk of incurring heavy medical bills in the event of major accidents or terminal illnesses. In the event if the sole breadwinner passed on, the insurance payouts can help to ease the needs of the surviving family members. From this perspective, insurance policies are not meant as an investment vehicle but rather as a form of protective shield. Indeed, there are many insurance policies that are linked to unit trusts or bond funds. However, these policies often don't meet the needs of the investors and due to volatile investment climates, the returns are often below expectations. Many of my friends and family members who bought investment-linked insurance policies often complained to me that they suffered losses in these policies. They blamed themselves for supporting their insurance friends who sold them these policies years ago.

I hope to share more of my views and my investment journey in subsequent articles.

Do write in to me at sgwealthbuilder@gmail.com for inputs, enquiries and your views. Do email me if you are interested to advertise in my blog, SG Wealth Builder as well!

Magically yours

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