6 Tips to Investing Success

Tip #1 - Getting Your Asset Allocation Right

Many investors over-emphasize the importance of picking the right company or bond or country to invest in. There is an equally large group that thinks the correct timing of the markets is the key factor to making profits. Well, they are wrong.

According to research, security selection and market timing are not the key contributors to investment profits. In fact these two combined only accounts to less than 5% of investment performance! No wonder most people lose money investing.

The most critical factor that contributes to over 90% of investment performance is Asset Allocation. Placing your money in a diversified portfolio across different asset class in the right proportions is the key to investment profits.

We have some backtested results (see chart below) showing the difference in performance between 4 of our company's well-allocated portfolios and relevant benchmarks. You will see that the our portfolios performed better than their respective benchmarks by as much as 6.6% per year! And this is achieved with similar, if not lower, level of risk (standard deviation). As a result, the return-to-risk ratio is much better for a portfolio with good asset allocation meaning the ‘asset allocation-minded’ investors are getting more returns for the risk that they are taking. 

Therefore instead of wondering what to invest in or when to invest, think of how to spread your investments across different asset classes, in line with your risk profile. Portfolios should be diversified across equities, bonds, real estate, and money market instruments to achieve lower risk that generates higher returns!

Tip #2 - Understanding Your Risk Profile

Which brings me to the important topic of risk profile. Understanding yourself is important in investing, and investing in line with your risk profile will help you to be more comfortable with your investments, hence helping you to make more objective decisions and be more disciplined. 

Different financial institutions adopts various ways to classify investors. Institutions in Singapore usually adopt the same standards as those used by the CPF Board, by having 4 risk classifications, namely:

- Lower Risk (risk averse)

- Low to Medium Risk (cautious)

- Medium to High Risk (moderately adventurous)

- Higher Risk (adventurous

Your financial adviser will be able to help you identify your risk profile, usually by completing a risk profiling questionnaire.After knowing which category you belong to, you will then be able to make better decisions when picking your investment portfolio.

Tip #3 - Rebalancing Your Portfolio

Once you have an optimized portfolio, it is crucial to 

keep it that way. As the price of the portfolio’s assets shift from time to time, the ratio between different assets may change, leading to a portfolio that is not optimized for your risk profile.

Portfolio rebalancing is performed by selling off excess assets and using the freed-up amount to buy into the assets that have dropped. By doing so, one is essentially selling high and buying low. It also ensures that the risk level of the portfolio remains comfortable for you. At large financial firms like ours, we have specialized softwares to help us do the rebalancing automatically.

It is recommended to rebalance your portfolio regularly. We help clients rebalance their portfolios on a quarterly basis.

Tip #4- Efficient Frontier Theory

Most portfolios are ‘inefficient’. This means that the returns that they provide are not the highest that is possible at a specific level of risk.

The  Efficient Frontier Theory is a concept in modern portfolio theory introduced by Harry Markowitz. A portfolio is considered ‘efficient’ when it has the highest possible expected returns for its level of risk. 

As you can see from the chart above, the most efficient portfolios are the ones that fall on the Efficient Frontier, which is denoted by the blue line. Those that are underneath the blue line provide lesser returns than the ones on the Efficient Frontier, and are therefore not worthy of investing in.

For individual investors, it is almost impossible to be able to determine which funds and what allocations are the most efficient. There are thousands of funds out there, with countless permutations. How then is one able to use the Efficient Frontier Theory to his/her advantage? 

The solution that our firm adopt is a partnership with Mercer Investment Consulting. Mercer have been providing investment advice to institutional investors for over 35 years, and they have more than 1,270 investment professionals and 105 dedicated manager researchers in 52 consulting offices worldwide. Through the our investment platform, Mercer helps our clients to develop customized portfolios that fall on the Efficient Frontier, hence value-adding to our clients’ portfolio. Therefore it is a platform that allows individual investors to receive institutional-quality advice.

#5 - Stay Invested - Don’t Time The Markets

There’s a saying: “the market is smarter than you”. That is to say, no matter how clever we think we are in outsmarting the market with the ability to pick the highs to sell and the lows to buy, the market will prove us wrong. No one is able to consistently be able to pick out the highest highs and the lowest lows to exit or enter the market. This also means it is prudent to stay invested in the markets, regardless of the ups and downs. Warren Buffet says that should the fundamentals of an investment be good, he is confident that it will rise in price. Any adverse movement in price is simply market noise.

Backtested market results show that should an investor miss out the best 60 days in the trading calendar, he will fare poorer than if he were to close his eyes and stay invested. Looking at the chart below, the difference between staying invested and missing the best 60 days in the global equity market is an incredible 12.9% p.a., and the investor would suffer a loss of 5.8% should he get his market timing wrong, when he would have gotten 7.1% profit should he stay invested. The price is too much to pay for getting it wrong, isn’t it?

Tip #6 - Dollar Cost Averaging

Dollar Cost Averaging (DCA) is an investment strategy that requires one to invest a fixed amount of money at a regular period of time over the long term. This strategy is particularly useful to reduce impact of market volatility on one’s portfolio.

The gist of DCA is with a fixed amount of investment, you will buy lesser of the investment when the market is high, and buy more when the market is low. This also have an effect of averaging out the purchase price of your investments.

Assume we invest $1,000 spread over 5 years in ‘Investment A’ that looks like this:

Over 5 years, the total value would be $6,071.70.

Let’s compared to ‘Investment B’ that moves down and up like the following:

The total value of the above investment would be $6,666.66. That is 9.8% higher!

Why did the investment that dropped 50% and went back to its original price outperform the one that rose steadily over the 5 years? The reason is because when Investment B dropped to $0.50, our $1,000 is able to buy double than when it was at $1.00. Therefore more units of the investments were accumulated. When the price of Investment B went back to $1.00, you have more units growing for you as compared to Investment A, whereby you are buying lesser and lesser units as the price goes up.

Here’s a chart that shows the effect of regular investing through DCA (red line), compared to a lump sum single premium investment (blue line).

As you can see, with DCA, the returns increase especially after major crises, as the price of investments drop and allow for more units to be purchased, often at steep discounts. 

Therefore it makes sense to invest systematically on a regular basis, rather than on a lump sum basis. Even if you have previously invested a lump sum which had not worked out, you can still top up your investment regularly from now onwards to bring down the average purchase price of your units (should the current price be lower than the initial purchase price).

By following the 6 golden rules above, making fruitful returns from your portfolio will be highly achievable. Of course, always maintain a long term view and remember that investing is about buying something of value and holding it, not selling prematurely.