How you can build your own investment portfolio
For those in their mid-30s to 40s, it can be a challenging period financially. You are most likely faced with having to support your young children, ageing parents, and trying to set aside money for your own retirement. At the same time, there are ongoing financial obligations to be fulfilled – mortgage, insurance for the family or perhaps funding the healthcare costs of your elderly parents.
While it can be overwhelming at times to juggle all these responsibilities, having a good financial plan can always help to alleviate unnecessary anxieties from unforeseen circumstances. At the same time, it is important not to neglect growing your wealth during this crucial life stage. If you have always wanted to invest or have already started casually, it could be a good time to look at building an investment portfolio in a more disciplined manner to fulfil your financial goals.
An investment portfolio is a collection of all the asset classes, consisting of stocks, bonds, properties, commodities, cash, and cash equivalents, including exchange-traded funds (ETFs). Different individuals have different risk appetites and financial goals and hence the allocation of funds among assets can vary widely from one investor to another but can still meet each of his desired outcomes.
Before you set out on your journey to build your own investment portfolio, we have some tips for you to better assist you in building a simple and effective portfolio.
5 essential points to consider when constructing an investment portfolio
1. How much money can I afford to invest?
There are no definite answers to how much you should invest as it is largely dependent on your financial situation. For instance, a PMET in his early 30s who is single and stays with his parents could likely afford to make large, lumpsum investments after years of building up his career. Without a mortgage to pay for or his own family to take care of, he can afford to take on more risk as well. A fresh graduate, on the other hand, might be more suited to take up a Regular Savings Plan that allows him to invest $200 a month over a long period.
You will have a clear understanding on how much is available for investment given your monthly salary and also after accounting for your emergency savings (minimum of 3 – 6 months of your average monthly expenditure), household expenses, insurance premiums and loan repayments.
You should also note that it is not advisable to commit more than you can comfortably afford in the long-term. This is crucial as you do not want to be caught in a situation where you have a lack of funds to cover unforeseen costs.
You may be thinking that it is possible to liquidate some of your investments prematurely if you meet such unforeseen circumstances, but this is not recommended as what you will receive in return is subjected to the prevailing market conditions and there is a possibility that you may end up losing money from your sale. This would also disrupt your investment plan.
Having said that, if you are currently a member of the sandwich generation and have not made any investments, there are various low-cost ways to start investing.
a. Dollar-cost averaging
As the name suggests, dollar-cost averaging (DCA) allows the investor to split up the amount he/her wishes to invest across a time period. A fixed amount is set aside each month to buy investment products such as stocks, ETFs and unit trusts. Doing so allows the investor to reduce the impact of market volatility. It also avoids the pitfalls of timing the market wrongly, as seen below.
With DBS, you can invest in ETFs or unit trusts by DCA with a regular savings plan (RSP) like Invest-Saver. With Invest-Saver, you can invest for as low as S$100 a month and there is no need for a trading account or a CDP account (required for the purchase of individual Singapore-listed stocks).
If you ever face a situation where you need to liquidate your investments, you do not have to worry about early withdrawal fees as there is no lock-in period.
DCA investing works best as a long-term investment tool for investors with a lower risk tolerance and do not have a large amount of cash to make lumpsum investments.
This makes it an attractive proposition for a first-time investor but above all, you should do your best to stick to your investment plan. That way, you are more likely to see it bear fruit.
b. Investing in ETFs
A diversified portfolio contains a wide variety of asset types and limits the exposure to any single investment. This means that the risk of loss is minimised if one investment performs badly over a period. Diversification also provides capital preservation as well as allows for the generation of returns from multiple sources.
If you are eager to start investing and have enough capital to do a lumpsum investment but not sufficient to build a wide-ranging and diversified stock portfolio, buying individual ETFs to build a portfolio may be the option for you.
This is because buying into one ETF gives investors access to the performance of a larger portfolio of stocks or bonds. For example, the SPDR Straits Times Index ETF holds 30 stocks to replicate the Singapore market index. There are even ETFs that allow you invest in themes like Technology or Medical plays.
Moreover, ETFs have lower costs compared to unit trusts. Management fees are lower because they are passively managed and do not employ fund managers for stock selection like for most unit trusts. These fund managers simply buy the stocks to replicate the underlying index.
ETFs suit investors who are not trying to get better returns than the underlying index – that is, people who are satisfied with matching the index in returns performance.
Choosing the appropriate mix of ETFs can create an optimal portfolio for your long-term goals.
An alternative way for novice investors to start investing is through robo-advisors. In the last few years, robo-advisors or robo-investing stormed into Singapore and has become increasingly popular. Like ETFs, robo-advisors offer lower costs to entry and charge lower fees while providing investors with access to regional or global diversification.
Robo-advisors are digital platforms that provide automated, algorithm-driven investment services with little human intervention. A typical robo-advisor collects information from clients by having consumers fill out detailed questionnaires online about their financial goals, risk tolerance and investment timeframes. It then takes this information and uses computer algorithms to come up with an asset allocation that fits the customer’s needs, before offering advice and/or automatically invests clients’ assets.
Robo-advisors typically provide a fixed set of managed portfolios that cater to investors with a broad range of risk appetite. The underlying instruments include ETFs, unit trusts and index funds.
While usually automated and algorithm-driven, there are also hybrid robo-advisors in the market like DBS digiPortfolio, where professional fund managers work alongside automated processes like back-testing, rebalancing and monitoring. This brings the insights, advice and human touch from portfolio managers, and fuses them with the speed of technology.
While not fully customizable to suit the needs of each individual investor, robo-advisors still provide a range of options for different investors.
Taking DBS digiPortfolio as an example, investors can invest in either an Asia-focused or a global portfolio at varying risk tolerance levels.
There are 3 versions of the same portfolio including conservative (Slow ‘n Steady), balanced (Comfy Crusin’) and aggressive (Fast n’ Furious). The higher up the risk spectrum, the more your portfolio is weighed to equities. What’s more is that the DBS digiPortfolio only requires a minimum investment amount of $1,000 and has a low investment fee of 0.75% per year!
2. What is your personal investment philosophy?
Before you embark on building a portfolio from scratch, one of the key questions to ask yourself is the kind of investment strategy to adopt. This can be a long process as there is a variety of approaches to choose from, each with its own advantages and disadvantages.
An investor usually builds a portfolio with a strategy in mind, which guides investment decisions based on goals, risk tolerance, and future needs for capital. In other words, it results in choosing the proportion of each financial instrument (e.g. stocks, bonds and alternatives) that make up your portfolio according to some key considerations for investing.
There are 3 important considerations to start with when choosing an investment strategy, they include taking measures to understand your:
- Investment goals/objectives
- Risk appetite
- Time horizon
Strategies include those that seek strong, rapid growth at the expense of higher risks. In contrast, investors can choose to focus on generating dividend income and preserving wealth.
Investors can also look at adopting both styles. One such strategy that combines both is the Barbell Strategy advocated by DBS Chief Investment Office (CIO) since August 2019.
Different investing styles will reap different results, but this does not necessarily mean one is better than the other since we all have different objectives that we hope to meet. You may also find that different strategies will yield various returns depending on the market cycle.
In all, it’s especially important that you understand your willingness to take risk in the markets.
Moving on, here are 3 common ways used to classify stocks:
- Dividend stocks
- Growth stocks
- Value stocks
Dividend stocks, also known as income stocks, are equities that are noted for paying relatively stable dividends and often have stable share prices too. They may pay an increasing dividend over time as well.
Many dividend stocks are blue-chip companies which are large firms that are well established. These firms have a long history of good financial performance, have enjoyed more stable growth, and pay more stable levels of dividends.
They might be less exciting than investing in companies heralded as the “next big thing” which have the potential to bring in significant capital gains, but they do give a sense of comfort to the conservative investor. Investors that are looking for steady streams of income at low risk would usually invest more heavily in such companies.
While not a like-for-like substitute, Real Estate Investment Trusts (Reits) and business trusts also form part of the dividend-focused portfolio.
Overall, ideal dividend stocks to add to a portfolio are those that have a low-price volatility, a dividend yield that is higher than government bond returns and a steady level of annual profit growth. Dividend growth for such stocks should also be at least level with inflation rates.
Although dividend stocks can be an attractive alternative for investors unwilling to risk their principal, their values may decline when interest rates rise.
These are companies that the market believes or expects to grow at above market average pace. Such companies are aggressively expanding and as a result, most or all of their earnings (if any) are reinvested back into the business to fuel the rapid growth. As such, these stocks generally do not pay dividends.
While higher risk, growth companies have the potential to grow immensely in the future. Investors anticipate that they will earn returns in the form of stock price increase when they eventually sell their shares in the future.
While every sector of the stock market has growth companies, those classified as one tend to have business operations reliant on emerging technologies that could be more entrenched in the future economy. This includes alternative energy, biomedical technologies and cloud computing among others.
Growth stocks can provide the investor with substantial returns, but they can carry a greater risk and may also experience greater price fluctuations. If market expectations aren't realized, growth stocks can see dramatic declines.
Investing largely in growth companies is more suited to investors who can stomach more risk or those who have a long-term investing horizon. Such investors would be in a better position to ride out volatile share price swings.
Furthermore, growth stocks are also more likely to be cyclical sensitive. This means they often perform better during periods of strong of economic growth.
Value stocks are publicly traded companies trading at a lower price relative to its intrinsic value and long-term growth potential. The intrinsic value of a stock is the value of the stock based on what a financial analyst estimates of a company’s fundamentals. As such, value stocks are undervalued in the current market environment but have the potential to grow and generate returns for investors in the future.
There could be different reasons why such stocks are undervalued. It could be due to public perception that has little to do with a company’s business operations or simply because the market has yet to discover value in a company.
Unlike growth stocks, value stocks are likely to have higher dividend pay-out ratios or low financial ratios such as price-to-book or price-earnings ratios.
While not considered low risk, value investing is often undertaken by moderately conservative investors who are looking for a lower risk option with a fair amount of upside potential.
There can be overlaps between value investing and dividend investing. This is so as established companies with a stable business, income and cash flow are more likely to pay regular dividends to shareholders.
Value stocks also often tend to outperform in a volatile or deflating equity market environment.
As you gain more experience in investing, your portfolio could consist of a mix of stocks from the above 3 categories so that your portfolio can be made more resilient to volatility.
3. Building up investment knowledge and experience
It is not an easy task to build an investment portfolio. Much research must be conducted on individual firms and industries. Undeniably, there is a good amount of reading to be done before you can feel confident about making your first stock or bond purchase, but you shouldn’t shy away from it. Do not forget that even successful investors and professional fund managers go through this learning journey.
Learning of the ins and outs of financial instruments and your personality as an investor takes time and patience. To build up on your investment knowledge, read relevant books or take an investment course that deals with modern financial ideas. There are many texts that distil financial concepts into digestible and easy to read points. Once you are more aware of how the market operates, you can then decide what works for you when it comes to investing.
In addition, staying informed on current affairs and market trends can help you make timely decisions too.
More importantly, the fastest way to learn about investing would be to do so hands on. Start early and construct an investment portfolio by making regular investments. Learning to be a successful investor does take time and your investment journey is likely to be a long one. That said, it will be worth your time and efforts.
Do be aware that you are bound to make mistakes (even some experts get it wrong!), which is why it is important to acknowledge mistakes and learn from them.
4. What is an appropriate asset allocation?
We have already covered the importance of understanding your financial situation and goals which is the first task in constructing a portfolio. Other essential factors to consider include your age and how much time you have to grow your investments, as well as the amount of capital to invest and your future income needs.
Secondly, you should take the time to arrive at your personal investing philosophy. This step is intrinsically linked to what the appropriate asset allocation for your portfolio would be.
As an individual investor, you need to know how to determine an asset allocation that best conforms to your personal investment goals and risk tolerance. In other words, your portfolio should meet your future capital requirements and give you peace of mind while doing so.
As a rule of thumb, younger investors, who tend to have a longer time horizon, often take on higher amounts of risk while older investors steer toward lower risk investing. If you have to take care of both your parents and children financially, you may not want to jeopardize your accumulated wealth by exposing yourself to high risk.
Below is an example of an asset allocation for a balanced portfolio. This is a portfolio for investors that seek to capture modest capital growth through a balanced risk-and-return approach.
This is one example of how investors can choose to break down their portfolio. A more aggressive allocation tends to include more equities while a more conservative approach sees the investor holding more fixed income and less equities.
Once you've determined the right asset allocation, divide your capital between the appropriate asset classes. They can be further split into sub classes, with each having their own sector specific risks and returns.
For example, an investor might divide the portfolio's equity portion between different sectors and companies of different market capitalizations, and between domestic and foreign stocks. The bond portion might be allocated between those that are short-term and long-term, government debt versus corporate debt and so forth.
5. Implementing and reviewing your investment plan
Once you have allocated your investments among different asset classes, you can start to construct your portfolio based on your ideal asset allocation. How you set it up depends largely on your investment knowledge and experience.
If you are lack the experience or have less time on your hands, you can consider using a combination of ETFs, robo-advisors, and unit trusts. They allow you to build a diversified portfolio with relatively little cost.
As you gain experience, more investible funds can be allocated to your portfolio. For retail investors, corporate bonds might not be the best option as the minimum investment sum is usually very high. As such, investing in bond ETFs may be a better option. Having said that, there are retail bonds like Singapore Savings Bonds and Temasek Bonds that require low investment amounts, so they may form part of your portfolio.
Given you are building your investment portfolio from scratch, do not rush into it. Building one requires patience and can take a few months. One way to do so is to pick products that are trading at more attractive valuations. You can look at more richly priced sectors following a market correction.
As you progress, do not sleep at the wheel and assume your investment returns are a given. Review your portfolio regularly and re-balance it as and when needed.
By regularly reviewing the performance of your investments, you will be able to ensure that they are on track to achieving your goals. You should aim to do this even if you are a passive investor investing mainly in ETFs or unit trusts.
Do keep a look out for investment costs which are the fees associated with buying financial instruments. The higher they are, the more they will eat into your gains. Hence it is advisable to consider low-cost instruments.
Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
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