How to invest for the long term, so you can retire on your returns

MANY people dream of being able to live off their savings, yet very few follow a strategy that gives them the best odds of reaching such a goal.

Ideally, everyone should invest regularly, for the long term, in diversified portfolios. Here are some ways we could be sabotaging our chances at achieving financial peace of mind, and what to do about it.

Problem 1: Too much cash

In Singapore, 35 per cent of financial wealth sits in cash. Excluding Central Provident Fund (CPF) monies, a whopping 53 per cent of households’ financial wealth is uninvested. This is nearly three times the percentage of wealth Americans hold in cash, and twice that of Australians.

And this is a problem because the average return we get on cash is less than today’s inflation rates.

Singapore’s latest inflation reading was 6.7 per cent year on year in October 2022. Savings accounts typically yield between 0.1 per cent and 3 per cent per annum, depending on how many of the bank’s conditions you can fulfil. Banks also offer a return of 3-4 per cent per annum on 12-month fixed deposits (as at November 2022).

So, money parked in savings accounts or fixed deposits is effectively losing more than 3 per cent of its value per year. While it’s important to have enough cash for monthly expenses and for emergencies, overinvesting in cash can put your goal of achieving financial peace of mind at risk.

Problem 2: Over-investing in property

Over the last 30-40 years, many Singaporeans built wealth by investing in real estate. As the economy grew substantially, housing prices followed suit: On average, home prices have grown more than 5 per cent year on year over the past 30 years – including substantial periods of double-digit increases.

Population growth contributed to the rising prices: In each decade from 1972 to 2012, Singapore’s population grew by 20 per cent to 30 per cent, with the highest growth rate (29 per cent) registered in the 1992-2002 decade.

Will Singapore property continue to offer the same returns? Nobody can know for sure. But population growth has slowed significantly, with the 2012-2022 decade registering only a 6.1 per cent increase.

While it makes a lot of sense for Singaporeans to invest in their primary residence, it’s less obvious that extra savings should also be invested in local real estate: that would be akin to putting all your eggs in one basket.

Problem 3: Putting all your money in a few stocks

Apart from putting too much money in cash or in property, there’s one more pitfall we should avoid: investing exclusively in a few shares we know or like. In 2021, many people fell into this trap and are now suffering significant losses as share prices in the tech sector have plummeted.

According to research by the CFA Institute, asset allocation drives 94 per cent of portfolio performance. Stock selection drives just 4 per cent of performance, and market timing accounts for the remaining 2 per cent.

The 2021 Spiva US Scorecard, which compares the performance of US active fund managers against their relevant S&P benchmarks, found more than 90 per cent of professional investors underperformed their benchmark over the last 20 years.

So, it’s more prudent to assess what percentage of your portfolio should go towards stocks, bonds, or real estate, for example, than it is to choose between stocks such as Google or Microsoft.

How, then, should you maximise your chances of building wealth?

One easy way is to make sure your portfolio has broad market exposure. Despite significant volatility – including several financial crises and countless newspaper headlines spelling doom – the MSCI All Country World Index has returned 7 per cent per annum since 1990.

The data is clear: Those looking to maximise their chances of building financial peace of mind should have significant exposure to global equity markets. Investing consistently, through the inevitable market ups and downs, is also key to growing long-term wealth.

Solution 1: Diversify, diversify, diversify

Investors should diversify equity investments globally, across geographies and sectors.

Maintaining broad market exposure reduces concentration risk in a portfolio, and smooths out the volatility of its returns over time.

Solution 2: Balance portfolios

Including fixed income and commodities in an investment portfolio allows investors to take advantage of these asset classes’ low correlations to equities. The prices of stocks, bonds, and commodities don’t tend to rise and fall together over the long run. As a result, investing in a portfolio with a mix of risky and protective assets lowers volatility and smooths out returns over time.

Balanced portfolios could generate lower returns compared with their pure-equity equivalents in the long run.

But if the smoothened volatility gives investors the peace of mind to stick to their plans and build wealth over time, then it’s a positive result that outweighs the negatives of feeling anxious in the market.

As most Singaporeans have a significant part of their wealth in CPF, those funds can be seen as a balancing part of their portfolios. CPF behaves like a government bond, as the Singapore government guarantees a return on CPF savings. So, don’t forget your CPF assets when determining your overall portfolio allocations.

Solution 3: Invest consistently

Investors should invest consistently over time – ideally with each paycheque. This investing strategy is also known as dollar-cost averaging, or DCA. Over time, DCA averages out the times you buy a security across market highs and lows, so you ultimately accumulate securities at close to their fair value.

And most importantly, DCA removes the stress of having to time the market, so you don’t have to worry about whether the markets are about to go up or down.

Ultimately, the current climate – in which markets are volatile and high inflation eats away at the value of cash – can seem daunting for any investor. But investing consistently into a well-diversified portfolio makes it easier to stick to your investing plan, and gives you the best chance of reaching your financial goals.

The author is co-founder and chief executive of wealth management platform StashAway.

*Amendment note: This article has been edited to correct population growth numbers.