A request came in from a reader (Hi Ted!) to learn more about how to start investing in his early twenties. In my first blog post, we learnt that investing is essential for building wealth. By starting his investment journey early, a 17-year-old can build up a fortune of $7.9 million! Yet curiously, our schools do not give practical advice on how we can get started on investing. Is the path to financial freedom truly lost to us? Certainly not if you stay tuned to this blog.
What Financial Instrument should I pick?
There are multiple financial instruments available, ranging from the low risk, low return fixed deposits, to bonds and stocks, all the way up to the high-risk, high-return derivatives. The golden rule to bear in mind is the risk-return tradeoff, meaning that potential return increases with an increase in risk. Your ability to handle greater amounts of risk and therefore strive for higher returns depends on several factors, including your number of years to retirement and risk tolerance. In this post, we will examine one of the financial instruments with the highest potential return and risk, stocks, along with how to select the right brokerage to handle your investments.
My Stock Investment Story
Back in the middle of 2014, I was taking finance classes and waiting for my internship to begin. Having just figured out the importance of starting early and utilising the Time Value of Money, I was impatient to start off my investing journey. Recognising that I had a long investment horizon and could therefore afford to take on more risk, I selected stocks as a starting point. However, it turns out that investing wasn’t as easy as going to the stock exchange, opening an account and telling the staff what I needed. Generally, you would have to pick a stock brokerage to handle your stocks and equities. Being the adventurous type, I did my research and finally decided to go with an online discount broker, Interactive Brokers (IB).
Picking your brokerage
I had a few major criteria when selecting my choice of brokerage.
- It had to be secure since I didn’t want to lose my capital, either to a scam or identity theft. I learnt about IB’s security from online reviews, and would later encounter another stock-savvy Singaporean using it to trade forex.
- Reliability was essential as I wanted the site to be online whenever I wanted to trade/manage my stock positions. Interestingly, Interactive Brokers’ app tends to go offline on Saturdays for maintenance. Besides that, it has proven to be very reliable.
- Preferably, it should be low-cost as I didn’t want to spend a lot on hidden fees, including transaction and advisory fees, which are often present with a traditional brokerage.
- The trades are nearly instantenous, making it superior
On the other hand, IB had a few unexpected drawbacks:
- It needs to be capable of trading in local stocks, preferably without excessive fees. This was a significant downside to IB since it is forced to charge additional fees if I were to buy Singapore stocks. My way of overcoming this issue was to invest in foreign stocks in a well-regulated country. However, the downside was that by doing this, I incurred currency risk.
- It required technical knowledge to utilise to its fullest potential. For example, as I was investing in foreign stocks, I had to convert my local currency to the other country’s currency. IB uses spot rates, which are superior to bank exchange rates, but it’s scary when you’re transacting in large numbers with the potential to put an extra zero when you didn’t mean to!
- An experienced stockbroker would have been easier to deal with, since you can simply instruct him on your transaction needs, leaving him to deal with the technicalities.
Overall, I would not recommend using IB if you are a highly risk-averse, cautious investor. However, the security and low transaction costs were simply too attractive to me. Fortunately, things turned out well for me. By picking a top-notch online brokerage and using smart stock-picking, I managed a decent return on my investment. (Think 50% in the first year!)
In fact, IB supports plenty of other products besides pure equities and forex. Some of the more esoteric products available include Exchange Traded Funds (ETFs), Warrants and Options. These are topics better left for another day, although I will briefly touch on ETFs later in this post.
Why not hedge funds?
At this point, some of you may be crying out: “Why should I make my own investments, when I can get an experienced hedge fund manager to do it for me?”
The simple answer is that hedge funds charge significant fees for their services, which eat into your returns. In the long run, you would be better off either investing in index funds or making your own investments.
Index Funds and Exchange-Traded Funds (ETFs)
Index funds strive to hold stocks in proportions that track a market index. Singapore’s equivalent of the market index is the Straits Times Index (STI), which is tracked by the STI ETF.
The attractiveness of index funds lies in their low costs and ease of maintenance. Instead of spending time and effort to keep track of how your stocks are doing, you would be relying on the stock market to rise in the long run. The STI tracks large, blue-chip stocks, which are generally lower-risk and fluctuate less than their smaller counterparts. Even the famed Warren Buffett is an advocate of index funds. In the long term, the stock market tends to rise, giving sizable returns to index funds’ investors.
Stock investing can be very rewarding, but it does require you to have immense patience. You must have the ability to stay in the market even when others are fearful or even if your stocks are falling in the short term. It certainly is not for everyone.
We have covered the basics of selecting the right brokerage. Future posts will deal in-depth with the question of picking the right stocks, as well as alternatives to stocks. Remember, although you may make some mistakes along the way, taking your first tentative steps along the journey to financial freedom is essential to growing your wealrh. It is clearly preferable to letting your money sit in the bank and be eroded by inflation!