How do you invest in your early 20s, when you have little savings? I wont be covering topics such as stock picking or stock valuation as some articles points out that a chimpanzee could probably be better at picking stock than fund managers. I will cover instead on essential tips to start out and slowly grow your money.
1) Invest with money you can afford to lose.
Heard stories of folks going bankrupt due to financial crisis? Well one can never really go bankrupt through investment in stock/forex/gold/etc, if you do not leverage (borrow money) and play around with money you do not have.
In worse case scenario, you would be holding onto stock that are worthless, it wont really bankrupt you unless you leverage and invest with money you borrowed from banks, loan sharks, relatives, etc. When you invest with money you can afford to lose, you will also sleep well even if the market tanks 50% the next morning. Perhaps you wont be sleeping happily, at least you wont resort to jumping off a building due to investment failure.
2) Starting Out – selecting the right broker
This is one of the most important decision to starting out, your broker needs to be trustworthy and you would be putting money and holding shares with them. Also you will be spending lots of time on that platform, they should be easy to used with loads on education materials to help you along the way.
- Avoid scam brokers- there are a bunch of brokers out there just waiting to eat you. Avoid anything listed on Cyprus.
- Look for brokers that have a local office or are listed in US stock exchange with significant market cap and positive user review
- Find the lowest cost among those with good review. (this is very important in the long run). As you will find yourself throwing thousands of dollars on commission fees over the years.
- Market access – does the broker allow you to invest in market that you want to?
- Analytic – This is important as it keep tracks of how you have been doing over the years. Most local brokers lack this.
I personally use Interactive brokers as it offers the lowest commission and huge range of market access with good portfolio analysis. Catch is you need at least 10K to start an account with them. If you do not have that amount, I would suggest using Optionsxpress as it has a local office in Singapore.
I have also written a longer article on why i choose interactive brokers vs local brokers.
3) Diversification – dont put all your eggs in 1 basket
About 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks – owning a number of stocks reduce the unsystematic risk.
This is easily said but quite impossible to do without huge capital if you are investing solely in Singapore stock market. Silly as it sound, Singapore stocks requires one to buy stocks in lots (size of 1000). You cant just buy 1 stock, you got to buy 1000 stock. Suppose you were to buy 1 stock in banking (OCBC), 1 in telecommunciation (Singtel) and 1 in healthcare (raffles medical) ~ you would need at least SGD 20,000 at this point of writing. To get 12-18 stock you would probably need at least 60K – 80K SGD.
That is silly and hence, I ceased investing in SG stocks (except via my CPF) as it was impossible to achieve good diversification just via buying SG stocks. Furthermore,in true diversification one should be buying stocks/bonds/etc from all over the world instead of a single region.
The infographics highlights where should our assets be as we grow older. Generally, most of us (Singaporeans) either put too much in real estate or hold too much cash.
So how do I diversify with small amount a small capital?
Trade in US/EU stock market. US/EU stock market allows you to just buy 1 stock. Say you have just $1000 USD, you can buy:1) 1 x Apple – 140 2) 2 x Microsoft – 90 3) 2 x walmart – 150 4) 3 x coke – 120 5) 10 bank of america – 160 6) you get my point dont you….
Its much easier to diversify by purchasing US/EU stock than just purely investing in Singapore Stocks.
Do note however that the more stock one purchase, the higher would be the transaction fees from brokerage. Suppose you were to buy 10 stocks with $1000 dollars via local brokers such as poems, you would like be spending $200 in commission ($20 SGD min per transaction). That is already 20% of your original investment, even cheaper alternative such as optionxpress would set you back by $100 or 10%. Interactive brokers would just set you back by $10 dollars, but they have some other annual fees which will also set you back by about 10% (based on the $1000 USD capital) . This would bring me to the next point -index funds.
4) Buy index funds
The only way to diversify with small capital is to purchase funds. Funds essential holds a portfolio of stock and when purchasing a fund, one would be essentially purchasing a portfolio of stocks.
Why index funds?
- Index are the benchmark, rather then choosing among funds, you could be better off buying the index
- low cost ~ low commission, low management fee
- well diversified
An example of index fund would be Vanguard S&P 500 – which essentially tracks a portfolio of stock similar to S&P 500. It currently trades at $183 – with $1000 USD, you would be able to buy 5 of them and have a well diversified portfolio.
Read more on index funds here
5) Stay away from mutual funds, investment linked insurance products.
While mutual funds and investments linked products allows you to own diversified portfolio, they should really be avoided because:
- Chimps can invest better- hence you would not know the mutual fund you bought can be better off than the index fund
- They cost more- Mutual Funds have a buy in rate of 2% – 5% and an average expense ratio of 2%. This means that your $1000 dollars would become $950 (assume 5%), immediately after your initial investment. And suppose, the market remains flat for the year, you would lose another 2% due to annual management fee.
- Index funds cost less - No buy in fees, expense ratio from as low as 0.05%
In the long run a pool of mutual funds will under perform index funds by the difference in the expense ratio.
Dont just take my word for it, here’s Warren Buffett on index funds:
My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers. ~ Warren Buffett
6) Plan and invest continuously
Lastly, only fools time the market. Market up or down, continue to invest throughout your 20s and reap the rewards on compound interest.