Finance Smiths

I’m still here. I know it’s been more than a week since I last posted. Was busy with a few things at work and outside of work. But I got through them and got a bit of time now to write about stuff. On the financial front, nothing much seems to be happening. I’m satisfied with how the monthly bank investment plans and contributions to robo-advisor accounts have been progressing.

I’m aware that equity markets are at all-time high for this year (2017) and it’s not an ideal year to start Dollar-Cost Averaging (DCA). But I rather start deploying my cash funds regularly than delay, let it build and not know when to use it. Case in point. I have a sum of USD in my foreign currency settlement account that has been sitting there for a while and earning next to nothing in interest income.

I hesitated with what to do with it (i.e. invest or transfer out to my SGD account) and now that the USD has depreciated against the SGD with the equity markets climbing higher, I’m even more stuck than before. In fact, the same thing happened with a sum of GBP in my other foreign currency settlement account but the depreciation of the GBP against the SGD is much worse.

Yeah, it’s not so easy to time the markets. I’m fortunate to have a bunch of friends that are several years older than me with kids. It gives me the benefit of looking at how their lives have turned out based on the personal and financial decisions they have made. Their advice have also been useful in guiding us on how we make the same or different decisions. These life lessons are good learning points for us.

Navigate your corporate career when you plan to have kids

This is important for working men and essential for working women. We don’t have a blueprint of how our corporate career will progress. In fact, we don’t even do detailed planning on it. We moved from Melbourne to Sydney then to Singapore to chase job roles that were interesting and offered different working experiences. But when you are starting to plan for kids, you cannot afford to navigate your corporate career in such a manner.

There seems to be 2 ways to do this. Either we stay in low enough experienced positions where the workload is manageable or we move to high enough experienced positions where we can manage our workload. But both as part of a team and firm that we have been comfortably working in for a long time. I seem to be moving towards the former while my wife seems to be moving towards the latter. We are trying to avoid getting stuck in low level positions with high workloads in a dysfunctional team and firm. We have seen the damage acrimonious working environments can cause when you just had kids.

Get your savings and investments financial infrastructure in place before you have kids

Trying to get your savings and investments plans up and running when you just had kids is tough. There’s little time to think about what bank accounts & credit cards to have, what stocks & bonds to invest in, when you are busy managing your children and career. Do it now when you have the luxury of time to consider most of the factors, practice the steps and refine the system. Doing it later as a working dad and mum just increases the possibility and cost of failure, which can have far-reaching negative financial consequences. The last thing you want is to be stressed about your kids, money and work at the same time.

Timing the equity and property markets is tougher than you think

This continues to be the main financial takeaway from our friends. They have been through a few equity and property markets cycles. You see quite a range of outcomes even though most of them are financially savvy. Especially when all of them entered the 2007/2008 Global Financial Crisis severe market downcycle at the same time with good jobs and decent savings & investments. They were positioned well to take advantage of the equity and property markets crash in 2008 and 2009. Unlike us, where we just graduated into a bad employment market with entry-level or no jobs and little savings & investments.

Some of them took small positions in the major bear markets and profited from the subsequent rebound. The rest went into or stayed in cash because of higher retrenchment risk and things didn’t change much for them. Although none of them lost their jobs in the end, nobody took big positions to generate significant wealth. That period of time was one of the worst or best time to stay vested or invest depending on your personal and financial circumstances. But it was a great time to build wealth in hindsight. Only problem was it’s difficult to make that call even when you are at the right place, at the right time and with the right amount of cash funds.

The fact that none of them could do it despite being financially savvy means market timing is not easy to execute. The norm is for most people to fail to pull the trigger or pull the wrong trigger. While the exception is for a small number of people to pull the correct trigger. I honestly think I’m going to be the norm rather than the exception when it comes to market timing. I have already demonstrated that in the minor bear market we had in 2016. Didn’t utilise enough of my cash funds. Sold out too early when there was no reason to and lost gains on the remaining market upswing. Didn’t stick to my asset allocation strategy.

I know it comes down to being inexperienced. I’m hoping my new DCA and Value-Cost Averaging (VCA) strategy will help to correct some of it by keeping me closer to the markets. But attempting this in a year when they are at all-time high doesn’t bode well for my confidence. Let’s see whether I improve over time!

Just to be clear. I’m still sticking to my Dollar Cost Averaging (DCA) and Value Cost Averaging (VCA) of index ETFs and robo-advisor accounts strategy. This post is my attempt at understanding how investing in ETFs can be a problem as more and more people engage in it. Specifically when people in different age groups, personal and financial circumstances invest in index ETFs.

My index ETF portfolio gives me broad-based exposure to various geographical and specific segments of equity markets globally. Although I achieve diversification, I pay a price in the form of only getting market returns on the index ETF portfolio. For your information, market returns is nothing to shout about. It’s probably the main reason why people still gravitate towards investing in stocks and other financial assets to obtain higher than market returns.

For market returns on index ETFs to work, you need to have a large cash savings and investment capital base. If you don’t have enough cash funds to invest in index ETFs, you are likely to find that the market returns is insufficient. In the event of a personal financial crisis, the low dividend yield on an index ETF portfolio means that you don’t have enough dividend income to sustain yourself. Which results in you selling your index ETF portfolio holdings first when the price is low and losing out on any subsequent market recovery.

The most powerful advantage of an index ETF portfolio is that the broad-based equity exposure allows you to tap into the market cycles of multiple businesses all over the world. A listed business available for public investment via stock markets is either growing or declining, either making profits or losses. Technological advancements mean that new businesses keep cropping up and old businesses keep dying at an increasing rate.

As the business market cycle becomes more unpredictable and you become busier with family and work commitments, the difficulty level of understanding the business market cycle well enough to profit from it rises. Which is why you now have people in different age groups, personal and financial circumstances switching to index ETFs to manage this risk.

This becomes a problem when you are in the group that cannot sustain this strategy in the long run because of insufficient cash savings and investment capital. Let’s run through an example of how this can happen.

You have S$10,000 of cash savings and S$10,000 of cash investment capital. I have S$100,000 of cash savings and S$100,000 of cash investment capital. We are both investing S$1,000 per month into index ETFs from our salary incomes. The economy is chugging along and our jobs are stable for now. The price of index ETFs is usually high during this time. Dividend income from the index ETF portfolio is only sufficient for basic living expenses.

A recession is triggered for whatever reason but we hang on to our jobs. The price of index ETFs drop and this is where the benefit of DCA comes in since we are still investing S$1,000 per month. We might even increase our monthly investments into index ETFs to S$1,500 per month. But we don’t change our investing strategy and continue to ignore the price of dividend stocks dropping. Switching now will expose us to individual business risk that we have not prepared ourselves to understand properly.

The problem starts when the recession worsens and we both lose our jobs. We want to take advantage of the even lower price of index ETFs. However, without salary income to sustain the monthly investments, we both tap into our cash investment capital. Remember that our cash savings is now being drawn down for monthly expenses since the dividend income was low to begin with and has dropped even further as dividends get cut.

You can last for about a year before you stop the monthly investments. From that point, you have to start selling portions of your ETF portfolio to manage the monthly expenses. Right when price of index ETFs is low. I can last for about 5 years before I have to stop. Let’s assume we are both jobless for a few years. A prolonged recession can last for about 5 years before the subsequent market recovery. By then, you have run out of cash savings and investment capital. With no index ETF portfolio, the subsequent market recovery does you no good. But the DCA would have worked in my favour the entire time.

When we eventually get jobs after a few years, my ETF portfolio would have rebounded and grown bigger but your ETF portfolio has to be started from scratch again. But this time round, you might look to take on more risk and build a dividend stock portfolio instead. Just to increase your dividend income to manage more than your basic living expenses.

However, the same problem exists with your insufficient cash and investment capital. But this time round, you are more exposed to individual business risk and market cycles. In fact, some of the listed businesses you invested in might not survive the next recession. While such stocks just drop out of index ETFs and get replaced with new stocks, the ETF portfolio holdings value doesn’t get wiped out unlike the individual stock holdings value.

Look at how index ETFs can work against you when you least expect it. I’m starting to realise that a long-term index ETF investing strategy works best if you have large cash savings and investment capital. By investing in the equity markets of various geographies and specific segments globally, you essentially tap into the growth of new businesses and limit your exposure to the collapse of old businesses. The upside is limited but more importantly, the downside is capped.

If you can last through the downturn and bear market cycle, you put yourself in a strong position to benefit from the subsequent growth. If you can’t sustain it, you may end up losing more than if you hadn’t built an index ETF portfolio in the first place. None of our index ETF portfolios have been tested so far so there’s no way of knowing who can survive then. The question is whether you have sufficiently prepared your other assets for the challenge.