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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!
Imagine this: You are a young, vibrant 23-year-old who has just landed your first internship or corporate job and wondering what’s the best way to handle your salary while planning for the future. Or you could be a 40-year-old married mother (Mrs 40) of 2 looking to balance the family budget. You could even be a smart 17-year-old hoping to be the next Bill Gates or Warren Buffett.
What’s the one major ingredient that is absolutely essential to guaranteeing your long-term financial happiness, regardless of who you are? Savings do help, but inflation and unexpected emergencies will chip away at the value of your money. Sure, you could place a huge bet on the lottery and become an overnight millionaire, but the odds of you winning are incredibly slim.
The answer, as demonstrated by successful people worldwide, is investing wisely and starting early. From 1 July 2017, Singaporeans can expect to work up to age 67, while nearly a quarter of Americans plan to retire at age 70. Yes, people in developed countries are retiring later than ever. Assuming a retirement age of 67, this means our 23-year-old will have 44 years to plan for retirement, while Mrs 40 will only have 27 years. Never fear, for she can still plan for her children’s future! Naturally, the bright 17-year-old stands in pole position, with an astounding 50 years to plan for!
My Story: How I Learned about the Time Value of Money
You may have noticed that I placed a lot of emphasis on the amount of time that you have before you get settled into that comfy retirement village (possibly across the Causeway). This is where I shall introduce my dear friend, the Time Value of Money (TVM). Simply put, a dollar now is worth more than a dollar in the future.
I encountered this concept initially while I was still studying in Junior College, but it was not until I actually began planning for my future that I came to fully appreciate it. Having landed an internship at a bank, I found that I was now in possession of a decent cash stream. As long as I fulfilled my obligations as a good employee, my bank account numbers would miraculously rise every month! Being a future-oriented person, I began contemplating my career path and indeed, how to best secure a comfortable retirement.
In order to “predict” my financial future, I pulled out my trusty financial calculator and performed a few simple calculations. Let me invite you to join me on this exercise. You may use an online TVM calculator, your own financial calculator if you have one available, or this Android calculator app that I have found to be most effective. We will perform these calculations from the perspective of the 23-year-old.
To begin, set the periods to be monthly compounding.
Let the Present Value (PV) = $5,000. (representing your savings)
Interest Rate (I/Y) = 5%
Monthly payments (PMT) = $1,000
Number of periods (n) = 44 years * 12 = 528
Computing FV gives us $1,961,045.
In other words, the 23-year-old would have saved up nearly $2 million by wisely investing his savings at a conservative 5% interest rate!
Performing similar calculations, Mrs 40 would still be able to earn an impressive $702,422 over 27 years. The precocious 17-year-old, with 50 years to invest, would end up with a cool $2.7 million!
At this point, you may be questioning some of my assumptions. Would a married mum really be able to squirrel away $1,000 every month? Could a 17-year-old student really have $5,000 in savings and save $1,000 every month?
Fine, let us adjust our assumptions for realism. Assuming Mrs 40 can put away $300 every month and begins with zero savings, she would still be able to earn over $200,000 by age 67. Compare this to keeping it in a bank at an interest rate of 0.1% per annum (p,a,), which gives her $98,520 at the same age. That’s over $100,000 lost, simply because she had failed to invest it properly!
Our 17-year-old has a far longer investment horizon and can therefore afford to go for greater returns at the cost of greater risk. Let’s assume he can reach a rate of 8%, but start with no savings. (Take a deep breath now, for the next sentence may take your breath away.) This leaves him with a cool $7.9 million! That’s $5.2 million over his savings with an I/Y of 5%, and $7.1 million earned over keeping it in the bank’s checking account! This is a perfect example of how a seemingly small increase in interest rate can truly add up to astronomical sums over the years.
Think of what you can buy with a million dollars! Now, what would you buy with seven million dollars?! Let your imagination run wild. A bungalow with a pool, with a Lamborghini or Porsche? Multiple Birkin bags, or luxurious LV shoes?
But how can we go about earning a 5% rate of interest on our money, let alone 8% or more?! This brings us to the real secret. Read the next section very closely, and digest as much as you can, for it may prove to be vital to your future success.
The Open Secret: Investing
The key to attaining an 8% rate of interest lies in proper investment. By having a proper portfolio of stocks, bonds and investment products, our 17-year-old can easily reach this interest rate over his long investment horizon. He needs to be well-prepared for short-term fluctuations in his portfolios, however, and not bail at the first sign of trouble.
On the other hand, Mrs 40 has a shorter investment horizon and more commitments, and she would be wise to invest it in a mixture of government bonds and insurance products, which would allow her to reach her desired rate of interest at lower risk. More detailed strategies will be covered in future posts.
Your future happiness is at stake. Don’t leave it up to chance. Start investing now.