2015 Retrospective

With the year 2015 coming to an end, I think it is time to look back on the things I have experienced and also evaluate myself in terms of my performance.

To start, let’s look at what happened to the World in 2015. From the Greek debt crisis earlier this year; bursting of China stock market bubble mid June and to the continuing oversupply problem of oil. The year 2015 is probably a very pessimistic year with seemingly more and more bad news everyday. We had witnessed the tragedy of Charlie Hebdo and Paris shooting that left hundreds of people dead; ongoing civil unrest in Syria that forced thousands to migrate and several mass shootings happened in the US. Year 2015 is not only a pessimistic but also a very tragic year, it is definitely not a good year by most people’s definition.

On the contrary, this year has been fantastic for me. A lot of things happened in the last 12 months: Started my first brokerage account and begin investing on stocks; read more books this year than my last 5 year combined; start to expose myself to different types of investments and business knowledge available by attending seminars; although sometimes disappointing, I believe my physical strength has improved because I started to go to gym, not to mention the amount of knowledge I received by researching and learning from others etc. Personally, I believe this is my most productive year to date. However, the year 2015 has not been a smooth ride either, it was a bumpy road with ups and downs. I had a few encounters at my workplace that were unpleasant to say the least (which turned out to be valuable lessons on social skills); had a few minor injuries which reminded me not to rush when trying to get results etc. With that being said, I’m still quite certain that I had a lot more ups than downs this year. I believe that most of the time, our definition of “down” is a matter of perspective, with mistakes, comes learning opportunities. I recently started reading The 7 Habits of Highly Effective People by Stephen Covey (A book I highly recommend to anyone who is serious about changing their lives), one of the things highlighted is that we are not the product of situations, rather we are the product of our choices. We take the sole responsibility for our life, because we have the freedom to choose whether to let something affect us or benefit us. Always remember: There is always another side of the coin, looking at things from one side is an opinion, when view from multiple sides you see the truth. 

Here I want to list down certain things that I have learned in 2015

On Investing

• Things that are cheap can go cheaper, retail investors are unlikely to get a bargain at the lowest price
• Do not invest in cyclical companies/industries until they show signs of improvement, trying to time industry rebound is not worth the effort
• Success in the stock market is a test of patience and consistency, not a test for activity
• Stocks is probably the only paper asset that award its participant the most for having long-term perspective and least attention in achieving so
• The market is full of geniuses who indulge in playing the market for short-term, the not-so-smart investor’s intelligence is to recognize who is on the other side of their bet and reduce foolish decisions
• Average investors react to market movements, successful investors allow the market to fall into their game plan and take actions

On Success

• Success is more than getting the right skills, skills can only take you from point A to point B, but the right habits and principles will serve you for a lifetime
• A goal is a dream with action plan
• It is crucial to know the difference between important and knowable. Our success is based on our effort in doing the important knowable; but often we spent time worrying about the important unknowable that is far from our control
• Success is a personal achievement, do not compare your level 1 with other people’s level 99, the importance is you are making progress in the right direction

On Relationship/Communication

• Do not put high expectations on other people. First, you will make others around you stressed out, Second, you will more likely to have disappointment than pleasant surprises
• An active listener gets more friends than an active talker
• Everyone is interested in their own things, you need to show them you cared about their interest
• Your capability to do your own job will not necessarily earn the respect of others
• Avoid using the word “If I were you, I will ……” because if you were the person, you will experience what he experienced, knew what he knew, felt what he felt and ultimately did what he did
• Always acknowledge other people’s difficulties before express your own. Successful negotiation comes from common understanding, not single sided demand
• Be aware of your emotions. Imagine yourself as a spectator in a conversation before making any comments which you will likely regret later

 

This makes the end of my 2015 review. It has been a great year, and now as I flip the page over to start anew, I’m confident that with the foundation I have built for myself in 2015 my 2016 will be even more awesome. Cheers to an amazing year ahead! 🙂

Fundamental Analysis Part 2

After performing business/industry analysis, we need to perform a management analysis. Why is this step crucial? It is because as normal retail investors who had low purchasing power, we often had little say in the operation of the business. The directors and the managers usually dictates the future direction of the company. As a shareholder and partial owner of the company, we need to make sure that the company is in the right hands so to ensure future successes. Here are some points to note when reviewing the business management

1. Integrity. This is a very important characteristic. As the owner of the company, you must make sure that your employees are trustworthy. Since we rely heavily on the company’s annual reports, we must make sure the information provided in the report is accurate and truly reflect the company performance. The directors job is not to sing about the good news of the company, but to provide information on both sides of the coin. They should treat public investors equally as they were business partners and phrase their reports as if they were writing to one another. Unfortunately, many company reports is used as a sales tool to boost up the company share price by painting a one-sided picture. This is hard to determine sometimes, I personally pay attention to the Chairman’s letter section, if its sincere and honest, I will be more interested in the company. (Note: multiple annual reports/chairman letters should be read before making judgement)
2. Focus. In the current state of economy, everything is connected and this stimulates growth. Often we seen it from the news or read it somewhere on the internet about the new trend/technology or the “hot stuff”. In the business world, companies will often be labelled and sorted out according to its “Growth potential”; usually the company has the highest growth potential will be loaded with expectations and investors which cause a skyrocket share price. Every  company wants a higher share price, in order to do so, many management decided to acquire growth by buying interest in high growth companies with hope that it will boost company earnings and therefore its share prices. The problem is, many of acquisition of such types occur in industries that have very little linkage with one another. For example, a property developer acquire an E-commerce company. The industry has little correlation with one another, therefore require different style of management. If the management buy into a company in an unrelated industry just because of hope of future return but lacks the understanding and capability to manage such company, the future earnings will not be materialized. I would prefer to invest in a company that is more focused in certain industries and at the same time careful with its acquisitions. Since no one can excel in all industries, it better to start with what you know and expand from there rather than try to make a huge jump.
3. Skin in the game. Since the management team has a high influence on the future performance of the company, therefore it is best to make the management be affected by their actions and make them more responsible. One way is to look at the ownership of the company. Management will often be rewarded not only in salary, bonus but also given shares of the company. If the management own low percentage of shares in the company, then their decision will less likely to affect their net worth; on the other hand, if the ownership is high, the management will be affected as much as the company shareholders. This align the shareholder interest with the management. To determine this, I would recommend looking at substantial shareholder section near the end of an annual report, i would be delighted to see some of the director’s name among the top 5. Furthermore, annual report will include the shares ownership of the directors, if most of the directors has increased their shares during the year, it means the management is more confident in the company; since the directors has the more accurate picture on how the company is being operated, increase in ownership is definitely a good sign.

These are the 3 major indicators for a good management, however, for retail investors, judging a management is probably the most difficult part when performing fundamental analysis since it involves many qualitative factors rather than quantitative facts. Retail investors must understand that most mistakes will be made in this part and therefore causing many disappointments. Hence, although this step is important, investors must be wary of their own conclusions about a management.

For Part 3, it is my personal favorite: The financial analysis. It involves looking at the financial report of the company. If you are a quantitative type of person, you will enjoy part 3 the most since it deals with a lot of numbers.

Fundamental Analysis Part 1

Beginning from this post, I would like to go more specific into the area of stock picking. In general, there are 2 ways of picking stocks, fundamental and/or technical. I will talk more about the former in this post. Both Fundamental and Technical investing has huge contents to cover, this subsequent contents are therefore in brief and summarized.

Fundamental analysis, FA for short is meant to look into the factors that able to affect the earning power of the company. It can range from things that are micro such as revenue and cost of sales to things that are macro such as the industry/economy performance. Fundamental analysis can be divided into 3 segments to focus on: 1. Business 2.Management 3.Financials. It depends on the investors own liking to prioritize these 3 segments accordingly.

So let’s begin with the Business segment. In this segment, the investors will focus on the areas of operation of the business itself. Certain questions the investor might wish to ask such as “How does the business generate profit?”; “Is the business able to generate a sustainable earnings?”;”What is the characteristics of this business?”. For example, lets take the Coca-Cola company, it is both a manufacturer and seller of multiple beverages such as Coca-Cola, Sprite and Fanta. Therefore the company generate profits by producing the syrups of its multiple beverages which can be further processed into the finished products we see on the shelves in many supermarket across the world. The company was founded in 1892 and the demand for its products are strong, therefore the company should be able to generate stable earnings for the next 10 years and more.  Furthermore, Coca-Cola has established a very strong brand name, it has integrated itself well with the American culture: this generated a competitive advantage over its competitors as customers show a preference for Coca-cola over other brands, this further ensure the earning power of the Coca-Cola company. Generally speaking, when invest in a company, to ensure its earning power, the company must be able to provide certain value to its customer. If not, the company will not survive. Therefore, this business segment aims to identify how the company provide value to its customer not only in the near term but also in the long-term. For the retail investor, he/she can start by looking at industry that they’re familiar with. For example, a doctor might start looking at certain pharmaceutical company or healthcare groups; a driver might look at certain auto manufacturer or maintenance provider; a housewife might start by looking at certain retail brands. The reason is because by starting with familiarized industry, the retail investor able to understand the business better, the group of customer the company service, the type of services.products provided, the demand for the services/products etc. This provided the retail investors a valuable advantage over the professional analyst as the analyst need to make preparation first before making a judgement. In fact, many successful investors recommended this approach, Peter Lynch recommended in his book One up on Wall street and also credited his wife for informing him about certain company. Therefore, start with the industry you are familiar with, get use to the process of stock picking before expanding to other industry. One of the common mistake made by investors is invest in things they don’t understand, therefore to ensure better investment results : Understand your investment.

For Part 2 I will talk about the Management Segment of this Fundamental Analysis

On Singapore GE2015

Today is the polling day for Singapore General Election 2015, probably the most competitive election in Singapore to date. 9 parties, all 87 seats contested. As I am not very well-educated in the subject of politics, this post is not meant for a deep discussion of the future of Singapore. However, there is one thing that interest me during the course of election: The discussion about CPF. It is the most debated subject during the past few days, and I am here to share my views.

CPF a.k.a Central Provident Fund, is the retirement scheme offered by Singapore government. Much like the 401k in the Unite States, it allow a portion of income to be taken out before you started paying income tax. However, unlike the 401k, CPF is compulsory and it is fixed at 20% of your income. Furthermore, a person’s CPF is divided into 3 accounts: Ordinary, Special and Medisave. Ordinary account offers about 2.5% interest rate and Special account offers approximately 4%(It is tagged to Singapore government bond). While compare to the average return in the past 10 years for the Straits Times Index it is not very exciting, however it is considered not bad as it is risk-free.  So what is the issue about this retirement scheme that makes it the most discussed topic? Apparently, due to Singapore economic growth and rising standard of living; Singapore is constantly ranked highly in the most expensive city in Asia. Goods are getting more expensive, people find their income can’t supplement their desired lifestyle. Furthermore, many elderly are forced to work beyond retirement age due to certain policies of CPF that do not allow one time lump sum withdrawal. There is a growing number of Singaporeans challenging the benefits and validity of CPF. People view CPF as a form of government scam. As a result, many parties(especially the opposition) suggested to have the CPF system abolished. I sympathize the elderly who had to work beyond retirement, however I am doubtful that the abolish of CPF is beneficial to Singaporeans. Imagine CPF is abolished, your monthly income increased. What do you do with these extra money? I believe many people will have this Pseudo-Rich feeling: Although technically you are still paid the same, you have more disposable income. Many people, especially the financially unwise will not use this fund for their retirement, instead they will probably spent it to “Supplement Desired Lifestyle”. For those who decided to save it, where they will find a place offer them risk-free return of 2.5%-4%? Singapore bank’s interest rate is almost 0%, fixed deposit is no better. For those considering investment, are the mass majority Singaporeans well-educated in the area of finance and investment? A recent survey shows Singaporean’s financial literacy is in the decline. I believe abolishing CPF is hardly beneficial, it is in fact more harmful for the Singaporeans. However, just like any schemes, CPF is not the perfect solution, it is flawed in many ways. Even so, I have come across many individuals who had studied the CPF policies and understand the opportunities it offers and made a fortune. These people realized the flaws and did not complain, rather they maximized the benefits of CPF by thoroughly understanding it. Personally I believe that people should stop expecting the government to come out with an alternative, the government cannot babysit every single citizen, it is our job to care about our own life and come up with a solution ourselves, since no one understand your needs more than yourself. Start managing our own finances, get financially educated, even if its basic money management. Start small and progress constantly, make the system work for us instead of enslaved by it.

Again, I want to stress that the content in this post is biased and only represents my own opinion on this matter. For those readers that might find this noneducational, I apologize as I know very little about Singapore politics. For those readers that might find it useful, I am happy to know that I provided some form of help to you. My final message for the post: If you want to change your future, take action and do something about it, life is too short to wait for change. 

Define Risk

In the previous post, I have talked about how the majority measures risk. While this measurement appears to sound logical, it is not how many great investors define it. In fact, many great investors have shared their views on using beta to measure risk and also their definition of risk.

Warren Buffett, arguably the greatest investor ever lived has always questioned the practicality of Modern Portfolio Theory(MPT). This theory is the basis of the invention of beta and efficient market theory. He commented that stock prices always fluctuate in the short-term, however it makes no sense that a stock with falling share price is risky simply because it did not move in tandem with the market trend. In fact, in certain circumstances, Buffett enjoys buying a stock with falling price. He enjoys buying with a ‘Margin of Safety‘-The difference between the price and the value of the stock. Therefore, the more the share price decreases the more margin of safety he will get, Hence the more the share price fall, the bigger the margin of safety and thus the less risky his purchase will be. His methodology is in stark contrast with MPT.

Buffett is not alone in questioning using beta to measure risk. David Dreman, the famous contrarian investor said “Higher volatility does not give better result, nor lower volatility worse“. He went on further to give his definition of risk:” Risk is the chance that you might not meet your long-term investment goal.” To him, there are 2 major factors that can affect you long-term investment goal: Inflation and Loss of Capital. This is a common understanding shared among many outstanding investors. This is because they understand the fact that diversification does not lower your risk, it is not a bullet proof vest. Diversification does not shield you from market crash, just look at how the mutual fund industry performed during the 2008 Sub-Prime Crisis.

Therefore, in order to define risk, we must first have a clear investment goal. It must be long-term. Any goal that is focused on short-term gain is either easily accomplished or quickly vanished. Once a clear investment goal is set, we must understand the threats present to harm this investment goal. For example, speculative acts which promises high rewards, unexpected events that require high financial expenditures, inflation etc. Once we understand that our investment goal can be easily sidetracked and affected by many factors, we must make the preservation of our capital the first priority of our investment. Warren Buffett had 2 rules when it comes to investing: 1. Never lose money; 2. Never forget rule no.1. He clearly understood the importance of capital preservation.

Therefore, I would like to end this post with my personal take on risky investments. I believe that what is risky is not about how much the price fluctuates from time to time, what is risky is that the investor himself has low guarantee of returning of initial capital while taken into account of time value of money. With that I hope you have learned something from this post. Happy Investing! 🙂

High Risk = High Return?

You probably heard it from the media; read it online or been told by your financial planner that one of the golden formula when it comes to investing is to TAKE ON HIGH RISK INVESTMENT SO TO ACHIEVE HIGH RETURNS. For a lot of people, this seems to make sense. Why so? It is because you need to be willing to sacrifice something in order to get something you desire. However, from my personal readings and researches, this golden formula does not seems to apply to the great investors.

Let us start by examining this formula before talking about the great investors. When people say High Risk = High Return, they always fail to mention that how high is high? How do you measure risk? In short, they often do not tell you the parameters used to define this formula. This is because they often do not have a set of parameters/numbers to define it. Recent years, the academics in the business school started using ‘BETA’ as a way to measure risk. The beta measures past-price movements of a particular stock/security against the market as a whole. It very similar to calculating variance/standard deviation in Statistics. This way, a beta closer to a value of 1 means that it is generally moving with the market average and considered ‘safe’ while a number greater than 1 means the prices react more violently than the market average and often deemed ‘risky’. The finance industry seems to welcome this idea of using beta as a way to define risk. As a result, many finance websites will have beta quoted alongside its respective equity.

The problem with beta is that it measures PAST PRICE movements. First issue is that it only uses historical data to define risk, it does not take into account any possible changes that might affect the prices in the future. It automatically assume that past price movement will determine future price movements without realizing it only do so to a limited extent.

Second issue is that it only uses price as a mean to define risk. This can be misleading. As we all know, market can be emotional and irrational at times. Investors can be highly optimistic and overly depressed from time to time; in fact, market does not stay rational for long, it’s always subjected to human emotions. Prices, which is set by the investors is often the product of the market emotional shifts. Thus, price is not a good parameter as it is often subjected to human factors. For example, if Coca-Cola  share price is gradually declining in a bull market despite its consistent earnings, the beta of Coca-Cola stock is going to label the stock as ‘risky’ as the share price does not move in tangent with the market average. This makes little sense, Coca-Cola is a great company with consistent earning, fantastic track record, great customer base etc, it only makes it a more attractive investment when the share price is decreasing!

Personally, I use an analogy that aids me in understanding this subject: I am a basketball fan and I like to play basketball as well. I wanted to buy a new pair of basketball shoes, so I did some research online first on which brand, then on which design… and lastly, any sales/discount available. I want to get the same pair of shoes as cheap as possible! This should not be surprising as it is common sense. However, when it comes to investing, common sense is rarely practiced by most people. The truth is, if you did your homework and identified the right investments, the more the price go down the happier you should be since you can purchase the stocks as a discount price. This is because you understand that the underlying asset is much more valuable than the price quoted, and the price quoted is merely due to the irrational behavior of the majority investors. Eventually, the misalignment between the price and the value will be readjusted. To put it in one of the greatest investor Benjamin Graham’s own words:

“In the short run, the market is a voting machine, but in the long run, it is a weighing machine”

Before ending, I hope I had convinced you that the use of beta is not a suitable way to measure risk as it is only measuring past volatility of the prices. Next time I will be talking about how the great investors measure and handle risks.

Happy Investing! 🙂

Choosing the System

One important thing when it comes to investing/trading is having a profitable system to follow. You can develop your own system or you can borrow and study someone else’s system. There are tons of such systems out there, in fact, if you pay close attention while you were reading newspaper or surfing the Internet, you will definitely notice some ads promoting certain systems. Just like buying stocks, you can’t just follow any system and expect it to work for you. So before you jump right in and follow the system,  there are certain things you need to consider.
The first and probably the most important thing to consider when using certain system is whether it is suitable for YOU. How do you determine that? Based on your personalities, characteristics and interest. For example,  if you enjoy statistics, a little bit adventurous and want excitements, trading system probably works for you; or if you are like me, lazy, a bit conservative and like to take small but steady steps, investing system is what works for you. In my opinion, people can argue what is the best system all they want, it doesn’t really matter to me. To me, investing is not a race, you do not need to beat anyone in order to win the game. If you like a system and it works for you, it does not matter if there are systems producing better returns. Road to financial freedom is a journey, it is supposed to be enjoyed along the way.
The next question to consider is whether it works in the LONG RUN. This is an important because most of the systems works but only a few works consistently and show long-term profitability. Randomly choosing a system to me it is like buying a brand new computer without looking at the specs. You might like the looks and the price,  but there is a high chance it will get outdated pretty fast. This is another reason I prefer investing than trading. This is because wall street and the market as a whole is full of copycats focus on short-term profits. These copycats will be constantly looking for the so-called ‘golden formula’ which will get them rich pretty fast. However, once a trading strategy became popular, it will lose its profitability as too many people are using the same system. In fact, the winning formula has always been: Doing what the others will not do.
The last question is regarding the PRICE of the system. If you are a poor self learner, you are probably considering joining some classes teaching you the system. Therefore there must be a price involved. You must decide if the price is reasonable. Will it provide you constant support from the teacher or is it just a one-time event? Will there be continuous recurring cost? If I use this system, how long do I expect it to make back the course fee?

It is essential to have a system to follow, however, do not be too dependent on the system you adopted. This is because, these systems are like machines, they need to be monitored and revised constantly. Most of the famous investors/traders’ system is customized to suit their style. For example, is widely known that Warren Buffett invest using a technique called “Value Investing”, however, if you study him closely, you will notice some of his stock purchases is quite different from how his teacher, Benjamin Graham described in The Intelligent Investor. Warren Buffett acquired knowledge from Benjamin Graham and modified it to suit himself. The key to successful investing is not what system to follow, is about your understanding of the market, having a niche so to achieve above average results. You need to be willing to take the time, understand what you are doing, identify your circle of competence and master the crafts. If you do not understand what you are putting your money into, why are you buying/selling and what is your niche, what you are doing is risky and harmful. Investing is more than just looking at charts and study the patterns.

A Note on Fund Investing

In this post, I want to share my personal thoughts on investing in funds. As this is sorely based on my own point of view, it may or may not be correct.

The fund industry is HUGE, there are thousands of funds out there and thousands of fund managers managing TRILLIONS of dollars. The market can often be affected due to the decisions of these managers. However, I personally do not like to put my money with the fund managers. Through my readings and research, I noticed a few things that might hurt the fund investors in the long run.

1. The Cost. In my previous post I talked about some of the fees involved when investing in funds. It is very important to consider these costs. This is because although the fee may seem small at first, due to compounding effect, it will eat into your investment returns over a period of time. Lets assume that the total cost of your fund is about 1.5% per annum and the fund return is about the same as the index; approximately 10%. Using some online compounding interest calculator. If I were to put $5000 dollars in and hold it for 10 years, the total return after fund expenses is $11,304 while an index fund costs 0.4% per annum accumulates $12,504. A quite small difference for a 10 year period. However, if you choose to put money into the fund every months (which is what a lot of people do), the result might be shocking. Lets begin with the same $5000, and at the same time an additional $1000 is added every month, fund expenses and return remain the same, 10 years later, the fund investor will achieve $189,326, while a 0.4% index investor will achieve $200,123. That is $10,797 differences, every year the fund investor lose out by almost $1800. The longer your holding period, the bigger the difference. Therefore, I believe, over a long period of time, an a high cost fund will be very damaging to the investor’s financial health.

2. The Performance. Just pay attention to the fund your financial consultant recommend you, most of the time you notice things like “no.1 Fund” or “Top performing Fund”. Many people put money into these top performing fund and achieve dismal returns. Why is that so? This is because in the fund industry, success in the past does not guarantee future performance. If you look back in history, many of the top performing fund 20 years ago are no longer in existence. Many studies have shown that it is extremely hard for a fund manager to beat the index over a 20 years period. Many fund were able to beat the index for 5 years, but unable to do so for the next 5 years, and nobody can tell beforehand which fund is going to beat the index for the next 5 years. Furthermore, studies have also shown that among the funds that beat the market, majority of them only managed to beat it by merely 1%. Which after fees and other expenses, the return is about the same as the index. One of the reason why many manager cannot beat the market is that the market is constantly evolving, the technique used by most managers were very similar and therefore they become the market itself since a lot of the fund manager buy and sell base on the same criteria and indicators. I would recommend A Random Walkdown Wallstreet by Burton Malkiel and The Little Book of Common Sense Investing By John Bogle for those who are interested in finding out more about the fund vs index investing.

3. The restrictions. As unit trust/mutual fund is mainly targeted at the common folks, it is subjected to a lot of regulations. These regulations prevented the fund manager from participating in many high risk activity, and therefore lowers the return in general. For example, certain funds are only able to invest in company that is above certain market capitalisation.  This means that fund manager can only invest in companies that reached a certain size. A lot of the times, this prevented the manager to invest in promising start-up companies as it is too small in size. These start-up companies, as they are highly dynamic have the chance to grow themselves rapidly and therefore its share price has the potential to increase its share price multiple-fold. Therefore, a lot of the funds will likely to miss out on this lucrative opportunity. Also, there are regulations restrict the total investment sums in 1 company by the fund manager. For example, the regulation may prevent the fund manager to hold more than 10% of the company. This will cause the fund managers to invest in multiple mediocre companies instead of 1 outstanding company. Some may believe that this is a good practice as it will cause the fund manager to diversify; however, if the manager is truly outstanding, he will understand the fact that a focused portfolio will yield superior result over the index in the long-term.

4. The structure. There are mainly 2 types of fund structures: Open-ended and Close-ended. In open-ended fund, the investors can buy into the fund at anytime and benefit from the fund performance, this is because this type of fund is willing to receive money from new investors at any given time. In a close-ended fund, the fund manager declares a maximum amount of money he will manage, and once that amount is reached, new investors will not be able to buy into the fund unless someone already invested in the fund decide to withdraw. Historically speaking, close-ended funds perform better than the open-ended fund. Why is that so? This is because in close-ended fund, the fund manager is able to have a better idea of its portfolio, and therefore make better decision when it comes of asset allocation and portfolio management. In an open-ended fund, as there are always new money coming in, the fund manager is often having trouble monitoring its portfolio. Furthermore, a lot of the times the fund manager of an open-ended fund cannot put money in the stocks he already purchased as the share price might have already increased; additional purchase may not generate desirable return for the fund. If the fund manager decide to put the new money into its cash reserves, often times it will annoy its investors as the fund manager is perceived to be not doing their job properly. As a result, the fund manager of an open-ended fund is forced to invest constantly. In the stock market, good bargains are few and only available for a certain period of time. Therefore, the fund manager who is always investing into new stocks usually do not have outstanding returns.

Personally, I believe that a person who invest in index fund or index ETF using dollar cost averaging will end up a lot better than the fund investors over the long-term. This is especially true if the investors do not know anything about the stock market and do not wish to be bothered by the stock market news. A lot of the famous investors have recommended this approach. However, if the person wish to achieve returns better than the index, he or she should start learning a lot more than the average investors. My favorite line in Rich Dad Poor Dad, ” Don’t be average”. Be an enterprising investor who does research diligently as recommended by Benjamin Graham and be a student of multidisciplinary approach like Charlie Munger has said.

Choosing the right fund

In the last post I talked about the different types of fund out there in the market. This post is written for the passive investors who made up their minds to entrust their money to the fund manager for their investments. The fact is, there are more funds than stocks in the market. Therefore, choosing the right fund is quite important for the passive investors.

The first thing to consider when choosing a fund is definitely its objective. It is important to understand the fund manager’s investment objectives. Is it more for capital preservation? Or is it more focused on capital appreciation? Some funds target a very specific group of people, such as age group and design their portfolio according to it. For example some fund are targeted at people who is currently 45 years old and planning to retire in 20 years time. Once you understand the fund objective, you need to ask yourself whether is the fund objective is suitable for you. If the fund objective is not aligned with your investment objective, it can be disastrous for the buyers.

Second thing to consider is the fund portfolio. I have mentioned in the last post, certain fund can be further classified into many different categories. You need to know the area of focus for the fund. How are the assets been allocated? Is it focusing on emerging market or developed country? Is it investing mainly on value or for growth stocks? I would strongly advise the investors to look at the top 5 positions of the particular fund of interest. This top 5 positions can give you a general idea of the fund portfolio.

Third thing you need to consider when choosing a fund is the fund manager. This one is a bit tricky than the last 2 points. However, if you carry out the last 2 steps, it should already give you an idea about how the fund manager invest. Now you need to look for more information on the manager’s performance. How long has the fund manager been managing this fund? How is the fund performing after this manager took over? Has this manager managed to beat the index? If you are not confident about the management of the fund then you should not place a single cent in that fund.

Lastly, you need to consider the fees of the fund. It is common sense, if we found something good, we want to get it cheap. The last thing you want when buying a fund is having most of your money ended up in the manager’s pocket as salary and bonus. There are certain fees involved when buying a fund. Firstly, it is the management fee. It usually ranges between 1%-2%. This is the fee you pay to the manager for managing your money. Secondly, there is front/back-end load fee. This is usually called sales charges. Front load fee incurs when you first purchase the fund. For example, a 3% front load means that for every $1000 paid, $30 will be deducted and your actual investment sum is $970.  Back load fee is very similar except it is charged when selling the fund. Third, there is 12b-1. The name maybe a bit strange, but this just refers to the marketing fees of the fund. A fund need to market itself in order to get new investors. The fees involved in advertising is known as 12b-1. Lastly, there is administrative fees. This fee is charged because of the operations of the fund. This include printers and paper, phone and desk services for the customer etc. Of all mentioned fees, only front/back-end load fees are one time. The rest of the fees are ongoing and usually charged annually.

Again, all of the information mentioned in this post can be found on Morningstar. I urge the investors who are considering buying a fund to find out all these information. When you do your research properly, you will be rewarded equally. 🙂

Unit Trust/Mutual Fund

This post is more suitable for the passive investors who wish to select a professional to invest and manage their money. Unit trust provided an excellent choice to park their money and enjoy nice returns.

The term unit trust and mutual fund can be used interchangeably, they all refer to the same type of investment vehicles. Mutual fund is used most frequently in the U.S while unit trust applies to other countries(I will refer to them as ‘fund’ in general for the rest of the post).  Basically, in a fund, average investors will entrust their money to a professional called fund manager. This fund manager, together with a team of dedicated research personnel will monitor the market for the average investors. Some of the well-known company such as Fidelity, Franklin Templeton and Vanguard provide many fund to different people with different financial needs. When a person purchase a fund, the purchasing price is also known as unit price. Unlike normal stock prices which fluctuate based on supply and demand, the unit price of a fund is affected only by the value of its portfolio. This means that the price of the fund change when the price of the stocks it purchase change. Since there are usually hundreds of stocks under the fund portfolio, the price fluctuations is a lot less volatile than normal stocks. Furthermore, the unit price of the fund is determined after the market has closed for trading. This means that the unit price of the fund will be fixed if purchased on the same day, while stock prices can change every minutes.

Lets talk about the different types of fund available: 1. Money Market Funds. This type of fund specialise in investing in short-term debts. Examples of such securities include commercial papers and treasury bills. In a money market fund, the fund manager usually invest in high-rating securities, meaning that the risk for default is very low. Therefore, in a money market fund, the return is usually very low since the manager takes very little risk. On the other hand, since the manager takes on little risk, money market fund is great for capital preservation.

2. Bond Funds. Just like the name suggests, this type of fund focus on buying bonds. This types of fund is also called income fund since bond annual interest rate is often fixed and therefore provide consistent returns. Since in this type of fund the manager takes on more risk than that of a money market fund, the overall return is slightly higher. Furthermore, some bond funds focus on certain area/sectors. For example, some bond may specialise in emerging market bonds, and some may focus on developed market. Depends on the area of focus, the risk level for the fund also change accordingly.

3. Equity Funds. This type of fund specialise in investing in stocks. The fund manager may invest across different market, industries and sectors just like bond fund. On top of that, equity fund can also be classified based on the investment styles of the manager such as value and/or growth. It also be divided according to the size of the company they focus on: Large, Medium or Small-cap. Generally speaking, this type of fund is riskier than bond fund and therefore generate higher returns. However, the risk level variations across different equity fund is even greater than bond funds. Therefore it is crucial to research on the focus of particular fund before you make the buying decision.

4. Mixed funds. This type of fund invest in wide variety of products. This include Stocks, Bonds, convertible securities and sometimes invest in other funds. According to different fund manager, different percentage of capitals will be allocated for certain investment product. If a person is interested, some of the major stake of fund is disclosed and available online. I would recommend Morningstar, it is a fund rating agency and probably the world largest company researching on the different funds available.

5. Index Funds. This type of fund is different from other funds listed above. Thanks to John.Bogle, the founder of Vanguard for bringing index fund to the market. The sole purpose of this type of fund is to mimic the performance of a stock market index. The portfolio of this type of fund is very similar to the index of a stock exchange. For example, in S&P 500, there are 500 stocks, so the portfolio of S&P 500 index fund will purchase all the 500 stocks. In this way, the buyer of an index fund is able to own shares in all 500 companies in the S&P 500. Compares to other fund, index fund is generally cheaper in terms of management fees as it does not require a dedicated research team to give stock recommendation to the manager. The risk level and return of the fund is dependent on the index it tracks.

I hope this post is able to provide you with a general idea on the different funds out there in the market. Subsequently I will talk about few things to note before buying a fund and my opinion on putting money in funds.