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Simple Steps To Investing

A thousand mile journey begins with a first step, so the saying goes. But be careful, if you do not know where you are going in the first place it can land you in the gutter. Similarly, in investing, this can happen as well.

A recent article in the Straits Times Forum shows that Central Provident Fund (CPF) members have indeed fallen into the gutter. It was reported that from 2002 to 2006, 83% of Central Provident Fund Investment Scheme-Ordinary Account (CPFIS-OA) investors, had a realised return of less tan 2.5%, which is below the minimum rate given by CPF. In fact 50% of CPFIS-OA members lost some of their capital.

So what happened? A possible reason is that some CPF members took the wrong step when investing. How then can wrong moves be avoided?

Set your goals & know your situation
The first step to take is to discuss with your adviser, identifying your investment needs and goals. Remember that not having a goal is like taking a bus to nowhere. Having goals can give you a direction and destination so that you know you are in the right place when you alight. Having goals also helps you to stay focused and be committed and disciplined.

Knowing where you are now is also important. So ask yourself these questions before you invest. Have you set up an emergency fund? Are you adequately insured? Are you currently working? What is your income level? How much do you save every month? Do you have huge financial commitments? Addressing these questions will ensure that you start with a firm foundation.

Your risk appetite
1. Your ability to take risk: this depends on the stability of your earned income and the time frame of your goal. The greater your income stability, the greater the risk you can take. Likewise, the longer your time horizon, the greater is your ability to wait out a bear market.

2. Your willingness to take risk: This measures your risk tolerance. For example, how well can you sleep during a market correction? How much do you know about investment? Did you ever have a bad or good investment experience? All these issues influence your attitude towards risk and hence, your willingness to take risk.

3. The need to take risk: This is dictated by your goals. How badly do you want to achieve your goals? What rate of return that is required to achieve your goals? What if you do not take necessary risk and are unable to reach your goals, what will happen? You will have to lower your expectations.

Analysing your risk appetite helps you to understand how much risk you can or should take. With the help and counselling of your adviser, you can understand better how investment works. At times, risk is necessary and can work to your advantage in achieving your goals.

Getting to your goal
Here you will determine the best route and suitable vehicle to take you to your destination. The vehicle will be designed according to your goals, your time horizon and your risk tolerance. Your adviser can help you to assemble the vehicle. If you prefer funds, your adviser will indetify the funds to be included to form the vehicle.

As a rule of thumb, you can have a conservative portfolio made up of 30% equities and 70% bonds; a balanced portfolio of 70% equities and 30% bonds. Each of these portfolios will have its own return and risk characteristics.

How to select funds?
Investors often look for top preforming funds. This ia similar to asking for a winning 4-D number. No one knows which fund will consistently perform the best. But if you are looking for funds that are likely to perform, there are a few criteria to consider. Sales charge, expense ratio, management fee, and return consistency of the fund managers are some important criteria for fund selection.

The operating cost of funds can affect the returns as well. Holding everything constant, a small difference of 1% to 2% can make a world of difference to your returns. Do not go for the flash in the pan return - which is a common sales pitch. Look for consistency of performance over a period of 3 years or 5 years.

As fund managers can come and go, look for funds that are managed by a team and not by an individual.

The bottom line when it comes to fund selection is not to buy funds with high operating costs and chase after yesterday's top performers, as past return is not a guarantee of future returns.

Keep an eye on your investments
Once you have decided on your investmen plans, remember your objective and do not be distracted by noises you hear along the way. Stay focused. It is better that your investment cruises slowly but surely than to swerve in and out of the lanes. Monitoring your investment posiiton is important as the investment environment can change overnight. Below are some methods that you can employ when changes occur:

- Rebalancing
Portfolios do not remain static. They change over time due to gains or losses of the component value of assets, and therefore the risks and returns changes too. When such changes take place, you need to restore the portfolio to its original position. A technique called rebalancing is often used to achieve this. It entails selling off part of the gain and buying the losing components. In other words, it involves selling high and buying low.

Rebalancing is done at a frequency agreed between you and your adviser. Sometimes, an ad hoc balancing is required because of an exceptional market condition.

- Review
Down the road, there might be changes in your circumstances. You might receive an inheritance; you got a pay rise; you have a new born child - all these events call for a review. You might want to reduce or to increase your portfolio risk because of these changes. Either reconstruct or tweak your existing portfolio to suit your new needs. Just remember, whenever you start a new portfolio for a new goal, the steps described above must be repeated.

Each goal has its own characteristics. There is no one-size-fits-all portfolio. Remember that time is every investor's best friend. Having time to your advantage can lower risk and achieve consistent return. The earlier you invest, the better off you are. So start investing today.

By, Jimmy Koh, CFP, Certified Financial Planner