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Seeking higher returns
IN INVESTING, a deceptively simple question can be asked: What return do you expect on your money? Going by a recent survey, Singaporeans have ambitious goals of 8 per cent or more. Historical evidence shows that to get there, you pretty much need to keep 100 per cent of your assets in stocks. The most reliable evidence over almost 90 years comes from the US market, one of the oldest, biggest and most diverse financial markets around.
It is from there that people get the notion that stocks can do well over the long run.
However, recent developments in financial markets have challenged conventional wisdom.
Asset managers used to get 8 per cent a year by sticking half their assets in stocks expected to return 10 per cent a year, and another half in bonds that offer a 6 per cent return.
This year, eight years after the global financial crisis, the safest bonds are yielding next to nothing. The 10-year German government bond, for example, is paying you a measly 0.2 per cent a year.
The 10-year US bond has gone from yielding 9 per cent in the late 1980s to below 2 per cent today.
Some bonds, such as the 10-year Japanese bond, are even yielding below zero.
In the current environment, the best opportunities for higher returns are in stocks - some of which are now cheaper after a correction, notably in this part of the world.
Yet the canny investor has to act only after understanding current events.
After the global financial crisis, central banks around the world, notably the influential US Federal Reserve, kept interest rates near zero to encourage banks to lend to companies, and to encourage consumers to take up housing loans.
If banks lend to companies with the right business ideas, the companies can invest in profit-generating ideas, creating new jobs and earning more so that it can redeploy the money again.
If consumers buy houses, higher property prices will trigger more construction activity, boosting the economy. Higher property prices will also make consumers feel richer, making them more likely to spend.
To keep interest rates low, the US Federal Reserve started buying long-term bonds from financial institutions in a programme called quantitative easing, essentially injecting them with cash that can eventually be redeployed elsewhere.
In Europe, the European Central Bank did something similar, as crisis after crisis around debt-laden Greece continued to flare up. Banks there were reluctant to lend and take risks also because of stringent capital requirements imposed after the financial crisis.
Much of the extra money in the financial system, created with the help of central banks, found its way into emerging markets where yields have been higher.
Property prices were pushed up, and governments struggled to contain them from spiralling out of control.
Adding fuel to the fire, China unleashed a massive stimulus in 2009 that propelled huge investments in commodity, infrastructure and capital goods projects.
More money flowed into commodity-producing countries such as Australia and Brazil.
Singapore's own rigbuilders participated in the boom, building oil platforms that can drill for oil in the most remote locations around the globe.
Companies, notably Chinese ones, borrowed larger and larger sums to finance expensive projects that were unsustainable.
In recent years, China began deliberately slowing down its economy, recognising that its current path of debt will lead to a financial crisis. Investment projects in commodities were re-oriented towards services.
In 2015-16, reality bit. Oil prices plummeted along with other commodity prices as China cut its demand amid a situation of oversupply. Companies, worried about a downturn, suddenly became reluctant to spend.
Yet all is not lost. Business cycles have become shorter and more turbulent, but across the world, people still need to eat, drive, buy houses to live in, and spend their extra money on goods and services.
In crisis-stricken Europe, an economic recovery has been taking shape after years of austerity.
The US has also grown strong, with unemployment falling to pre-crisis lows. Asia, meanwhile, remains one of the fastest growing regions in the world.
All these have added up to global gross domestic product (GDP) growing by 2-3 per cent a year steadily in the last few years.
In the much-hyped financial markets, things are more turbulent. Anticipating a long period of slow growth, funds have moved out of stocks in cyclical industries and emerging markets into the safest, surest bets: large-cap developed market consumer stocks, healthcare stocks, developed market government bonds, gold, the Swiss franc, the Japanese yen, and also the US dollar.
FINANCIAL PLANNING, FIRST
An 8 per cent return might be a long shot in this environment, especially when assets that tend to shrug off economic swings are trading at expensive levels.
Given how wants are unlimited, and reality is such that high returns are hard to come by, the more accurate question one should ask is: "What return do I need on your money?"
The right answer stems from proper financial planning.
Investors have to first target a sum that they require by a certain age based on personal requirements, and calculate, based on current assets, the annual compounding rate needed to get there.
To fulfil basic needs such as food and health care, it is likely that topping up the Central Provident Fund (CPF) will do the trick. At current guaranteed returns of 4-5 per cent a year for retirement account monies, it is the best deal on the market.
Those nearing retirement can, for starters, aim to have the enhanced retirement sum of S$241,500 saved by age 55 in the CPF.
With that sum, they can tap on the CPF Life scheme to get S$1,800 to S$1,900 a month from age 65, as long as they live.
Those who are younger will have to budget to put in a bigger sum by the time they hit 55.
To get a bigger sum, a trade-off has to be made: You can't buy an expensive house, for example.
INVESTING FOR BETTER RETURNS
Beyond the basics lie a plethora of arguable wants: overseas university education for the kids, world-wide travel, private medical care, an extra investment property, and so on.
A basic understanding of the different asset classes out there, and the risks associated with them, will be useful. Then investors need to understand what is cheap and what is expensive, and whether what is cheap will go bankrupt or not.
Where are the current opportunities? Traditional investments are in stocks, bonds and cash.
Cash yields nothing, but is the safest to hold on to. Singapore dollars are well backed by foreign reserves, so the risk of a dramatic depreciation is extremely low.
Singapore government bonds yield over 2 per cent a year for 10 years - not much, but still a base line to live by especially while transport and housing inflation stays low.
Some might want to trade foreign currencies and take on debt to do so. But keep in mind that currency movements are among the hardest to predict, and a currency can depreciate quickly if a country's financial situation goes south.
There are also opportunities in corporate bonds, which yield anything from the mid-single digits to the high single-digits for bonds issued by companies with a riskier business profile.
The retail investor typically should avoid buying a single bond due to its large ticket size and higher risks of not diversifying. Bond funds are available, but make sure that you know what the fund is holding. One or two defaults can significantly impact returns.
THE STOCK MARKET ALLURE
Stocks generally give the highest return potential. But they are the riskiest forms of investments.
Investors have to hold a reasonably diversified portfolio, and be patient.
It's all paper money until you sell. You have to be prepared for the most defensive of stocks to fall to half its value or lower in a recession, and much more if it was trading at expensive levels.
What is cheap out there now, relative to their earnings? Emerging market stocks, Hong Kong-listed China stocks, commodity and infrastructure-related stocks, cyclical stocks - companies that do well when discretionary spending recovers - are all trading at significant historical lows.
Yet much of emerging Asia is still growing. There will be opportunities to ride on human progress there.
Dividend stocks or funds have been popular. But keep in mind that dividends can be cut in a downturn, and the competitiveness of the underlying business is key.
Cyclical businesses like commodity-related stocks, banks and capital goods providers are also likely to cut dividends in a downturn, so you cannot trust the dividend yield.
Beyond traditional investments, we get into the realm of alternatives, which can be harder to value: property, private equity for the wealthy, commodities, hedge funds, gold, art, wine, and the like.
This is more sophisticated territory, as the success or failure of every investment can depend on very specific factors. As always, invest in something that you can understand, or find an expert whom you can trust.
Property is an Asian favourite. But it comes with its own issues. Risks of investing in property include illiquidity - meaning that you cannot cash out anytime you like - and operational risks such as dealing with tenant problems or leaking pipes. Rental yields in Singapore are low, but might be more reasonable overseas if you can stomach the foreign exchange and regulatory risks.
The bigger issue with financial markets in 2016 is that asset classes tend to move in tandem with each other. In investment jargon, they are becoming more correlated.
There is little point trying to puzzle out the differences between European, Japanese or Chinese stocks - and they all move up and down together depending on what the People's Bank of China does with the yuan.
TIPS TO DO WELL IN 2016
Investing is never easy. But by anchoring yourself to a realistic return target, and by speaking to as many informed observers as possible, you can avoid some of the pitfalls.
Starting early and small doesn't hurt. Better to make a mistake on 30 per cent of S$10,000 and lose S$3,000, thus learning your lesson, than lose S$150,000 later on in a mistake that you could have avoided.
Compare around. If you really like a fund, find out if it has competitors doing the same thing and whether the fund stands out. If you like a stock, find a few peers that are listed and compare their valuations and profitability.
And be patient. Invest slowly, prudently, and only money that you can afford not to use for the next five to 10 years.
Don't lose sight of the end goal, which is, for most people, to secure a better future for themselves and their children.
There are still plenty of well-managed, robust businesses around the world selling goods that people will continue to buy for years to come. Therein lies opportunity.
The year 2016 holds plenty of challenges for financial markets. Yet it is at the market's darkest moments that the best deals are found.