Back to basics to grow money
By Larry Haverkamp
DO you know the difference between a stock and a bond?
It is this: a stock means you own part of the company. A bond means you loaned it money.
Stocks and bonds are also called 'equity' and 'debt'. All investments fall into these two categories.
Both are ways for firms to get money to pay their bills or buy more assets for expansion.
A typical debt-equity split is 50/50. It means the business is financed half with debt and half with equity.
Companies get debt by borrowing, usually from banks. The equity comes from owners as well as past income that was never paid out as dividends.
It accumulates and is called 'retained earnings'.
That brings me to a new buzzword from this recession: De-leveraging. It means everyone wants fewer risks and it changes the world's debt to equity split from 50/50 to something less, like, 33/67.
Then, assets are financed one-third from debt and two-thirds from equity.
De-leveraging in action
Take 2006. A company may have had $200 million in assets, financed by $100m in debt and $100m in equity.
Now, in 2009, it still has $100m in equity, but debt would have fallen to $50m. It means only $150m in assets can be financed, and leaves the company no choice but to operate on a smaller scale than before.
De-leveraging hits households too. Banks now require that you put down more of your own money to buy a car or a home.
This is the 'new normal' and is likely to be with us for a long time.
Is it good or bad? Well, on the plus side, fewer risks mean not as many ups and downs in the economy. We will have fewer big recessions.
As explained, however, less debt means fewer assets to work with. The world will operate on a smaller scale. It will need fewer factories, office buildings and workers too.
It means lower growth and higher unemployment. Incomes will grow more slowly. Prepare to tighten your belt.
How to invest in the future
A company with more equity (ownership) and less debt (borrowing) is safer.
For an investor, it's the opposite: You take big risks when you own shares of a company (equity), and the safer investment is bonds (debt).
Which should you go for, high risk or low?
Most people say: Low risk. Why take chances?
The trouble with that is you also get lower returns.
Ok, let's try for high returns instead. Sorry. Then you have the problem of big risks. Hey, you can't win!
It is true. The pluses and minuses are exactly offsetting. As risks increases, so do returns.
Neither choice is better. Both are equal and fair. The choice depends on your risk preference. It is a personal decision.
Women, for example, often prefer safer investments while men take more risks.
Retirees usually go for safety while young people don't mind taking risks.
Here is a good rule of thumb: The per cent of safe investments should equal your age.
It means at age 50, you would divide your money equally between bonds and stocks. At age 90, you would have 90 per cent in safe assets like bonds and fixed deposits.
Risk v returns: advanced
A word of caution. Most people think higher risks mean higher returns. It's not always true.
Take gambling. The risks are very high but returns are low. In fact, they are negative. You are sure to lose in the long run.
It is also true for investments in contracts called 'derivatives'. Examples are options, futures, warrants, swaps and forward contracts.
(i) They expire after a few months and (ii) all gains and losses are offsetting, making them zero-sum before commissions. These two features make them more similar to gambling than investing.
Worse still, derivatives often come with high leverage. It magnifies the risks by 10 to 20 times while the average returns remain negative.
It isn't all bad. Derivatives can also reduce risks through 'hedging'. This is done by big companies and banks.
Most people use derivatives for 'speculation'.
This article was first published in The New Paper.
In Personal Finance or Financial Freedom . “Financial Principles” which are as useful and practical today.I’ve personally benefited tremendously and applying the principles therein and have experienced improvement in my own finances. Knowing and not doing it, is not yet knowing”. For example, You know that exercise is good for your Health yet many people are lazy to exercise. Knowledge is only POTENTIAL power. Knowledge is ONLY power when APPLIED.
1. Money comes gladly and in increasing quantity to any person who save at least 20% of his/her earnings (first step to Financial Freedom).
There are only 3 Cashflow Scenarios:
a. You spend more than you earn: This person has negative cashflows, spending future money and likely to end up owing other people money (eg. credit cards, friends, relatives, loan sharks). b. You spend all that you earn: whether this person is earning SGD$500 a month or SGD$300,000 a month, he/she is still "Just over broke".
c. You spend less than you earn (eg. save 20% or more of your earnings if possible). as time goes by, this person will automatically get richer and richer. I read SUNDAY TIMES this rich man say “every dollar you earn, do not spend more than 30cents” .Which cashflow scenario do you want to CHOOSE for yourself? 2. Money can work for you, if you become the “wise owner” of money and make money work for you. (note: you’re the Master, money is the slave, while many people are guilty of being slaves to money).
For extra value, focus on yield
By Dennis Chan , DEPUTY MONEY EDITOR
As a value investor, I am naturally attracted to investments that produce decent yields. This is because these investments tend to be more stable and less likely to give one a heart attack.
Other more gung-ho investors may prefer investing purely for capital gains, even if they are to get little or no yield.
My interest was therefore piqued when The Straits Trading Company last month offered for sale 10 units of its Gallop Gables condominium at Farrer Road by dangling a big carrot in the form of a guaranteed rental yield of 7 per cent for two years.
For those who are unfamiliar with the term, yield is the recurring annual income you get divided by the amount you paid for an investment. In properties, yield is derived from rental income. In stocks and shares, it is based on dividends that companies pay.
With savings in banks drawing a paltry annual interest of half a per cent or less these days, Straits Trading's offer was understandably snapped up by eager buyers.
Seasoned property investors will tell you that it's rare to get rental yields as high as 7 per cent, not unless you convert your property illegally into a workers' dormitory. For residential properties, a yield of 2.5 per cent to 4 per cent is the norm.
As an investment class, real estate generally provides a lower yield compared to investing in corporate bonds and equities. This is an acceptable trade-off as the risks of investing in physical properties are lower than those for stocks and shares.
The focus on yield, however, is only half the picture.
Another pertinent question an investor should ask is whether the current yield of a property is real or sustainable.
According to the Urban Redevelopment Authority, rents for private homes in the first quarter fell by 8.5 per cent. They had dropped by 5.3 per cent in the fourth quarter of last year.
In a prolonged economic downturn such as the one we are probably experiencing, there is further room for rents to fall. This is notwithstanding the recent revival in the residential property market.
On the demand side, numerous companies have slashed or are reducing head counts. Some have stopped operations altogether while many more have cut the pay of their staff. There is less discretionary income all around.
On the supply side, vacancy rates are likely to rise as more new homes are completed while some older developments that were earmarked for demolition have been put back into the rental market as their redevelopment plans get frozen.
Rising capital prices combined with falling rents spell bad news for yields, something property investors should be mindful of.
Equity investors tend to be more savvy when it comes to matters of investment yields and their sustainability.
Which is why the stock market today is littered with numerous instances of shares that seemed to be going for a song when measured against their historical yield. Stock investors are not buying these high yielding stocks because they suspect they will not repeat the high dividend payouts of the previous year.
To be sure, there are people who see real estate investing purely as a capital gain game. In the bull run from 2005 to 2007, many home owners were content to leave their units unoccupied while waiting for the right opportunity to resell them for a big profit.
Such windfalls are harder to come by in the current climate and a prudent investor cannot afford to look through the prism of 2007 and hope for a repeat of these fabulous gains any time soon.
For investors who acquire properties with the help of a bank loan, rental yield takes on added significance.
Mortgage rates currently vary from as low as 1.5 per cent to 3.75 per cent or more. As an investment, income from renting out a property should preferably be able to cover the monthly bank interest charges plus a portion of the principal repayment.
For those lucky enough to obtain a low rate such as Standard Chartered Bank's 1.5 per cent promotional offer for the first year, the bar for rental income is low.
But for those who are locked in to significantly higher rates, their rental income should at least match the interest they are paying for their mortgages if they don't want to end up working for the bank for free.
Don't forget, mortgage rates tend to rise over time as initial teaser rates give way to prevailing ones. One way for a borrower to maintain a low mortgage rate is through the regular refinancing of his home loan. But this assumes that the current low interest rate environment will remain benign.
Refinancing may not be feasible if the property's valuation has fallen sharply or if the refinancing bank decides to offer a lower loan quantum.
Unlike stocks and shares, yields on property investment are also more easily manipulated. A crafty seller can sometimes entice a buyer to overpay for a property by promising an abnormally high rental yield. To achieve this, the seller will sell his property and execute a leaseback agreement with the buyer.
In such a deal, the seller will guarantee the buyer for a limited period - typically not exceeding two years - a monthly rental income that will meet the promised yield.
The seller then sub-leases out the unit to a genuine tenant at the prevailing market rate. If the rent is below the guaranteed amount - as is likely to be the case for an overvalued property - the seller will top up the rental shortfall. But he does not lose out as he is able to count on the extra profit he had made earlier from selling his property at a higher price. The buyer ends up worse off even though he gets a higher monthly income rental for two years.
An example of how this can be done is illustrated in the accompanying table.
Rental guarantees are not illegal and, in fact, are the de rigueur practice of some developers that simply refuse to lower their selling price of unsold, completed projects during a downturn for tactical reasons.
They are also not necessarily detrimental to buyers.
Getting an attractive rental guarantee in today's market will appeal to investors who believe that home prices will recover by 2011 or 2012, as they will enjoy higher-than-usual returns in the next two years while awaiting the recovery to take place.
In the case of the Gallop Gables apartments, the buyers probably got a good deal.
Apart from getting guaranteed rental yield of 7 per cent for two years, these purchases were done, on average, at prices about 23 per cent below what Straits Trading had asked for last July.
The developer has since raised the price of the remaining few units to $1,400 per square foot (psf) from the $1,188 psf average it had sold at in the past six weeks.
But the cheapest unit still went for a tad above $3 million.
If only I had a few million dollars to spare.
Er, what is a bear market rally?
By Alvin Foo
Where do you see this?
In newspaper articles and stock market analyst reports.
What does it mean?
A bear market rally is a temporary increase in stock prices during a period when prices are generally plunging over months or years.
This rise usually ranges from 10 per cent to 20 per cent, and even as high as 30 per cent, from the lowest point. Trading volumes also surge.
However, market fundamentals remain weak and do not offer a clue as to why the markets are going up.
Overall investor sentiment would still be negative and cautious.
Why is it important?
This term has been used commonly in recent weeks, as stock markets have seen a substantial rally since early March.
For instance, the Straits Times Index has charged up more than 30 per cent to 1,920 on Thursday, after plunging to a six-year low of 1,456 on March 9.
In the United States, the Dow Jones Industrial Average saw a six-week rebound - its best streak since 1938.
A bear market rally favours nimble traders, who are quick to buy but also swift to take profit.
So you want to use the term? Just say...
'Be wary of investing in equities despite the recent rebound. Experts have warned that this is a bear market rally as the world economy has not yet seen a turnaround.'
Make market cycles work for you
By Dennis Ng
Observing nature, we will notice cycles.
There are, for instance, four seasons, with the cold winter followed by blossoms in the spring. And just when everyone is having fun in the sun, it is good to be mindful that temperatures will drop as autumn approaches. Those who are not prepared with sufficient clothing might freeze when winter returns.
Similarly in the financial markets, there are market cycles where busts follow booms and vice versa. That is why the 'party' ended with a market crash last year, after global stock prices shot up by between 200 and 500 per cent in the last four years.
According to historical analysis, 2008 was one of the worst years for stocks since 1937. For many, this might be depressing news but for me, this is exciting news. By observing market cycles and investing accordingly, one can try to time the market.
I would say that in the short term, it is difficult to time the market correctly on a consistent basis. However, it is definitely possible to roughly estimate at which stage of the market cycle we are in.
For instance, in 2007, the stock market was in its fourth bullish year. Back then, the Straits Times Index (STI) had risen about 200 per cent from a low of 1,226 in March 2003 to over 3,600 points.
As far as I remember, the Singapore stock market has never had a bull market that lasted more than five years. Believing back then that we were near the tail end of a bull market, I sold most of my stocks and avoided the market carnage that followed a few months after that.
The steps to 'market cycle investing' are simple.
First, we try to estimate at which stage of the market cycle we are in.
Secondly, we try to identify the major trend direction - upwards or downwards.
Finally, we position ourselves accordingly; basically, the strategy to take is to go with the trend instead of going against the trend.
For instance, if you bought stocks during 2004 when the stock market was on an uptrend, it was easy to make money since most stocks were moving up in price. However, when stock markets were in retreat last year, it was very difficult to avoid losing money on stocks, simply because most stocks fell in price in accordance with the general market direction.
Some people firmly believe in the 'buy and hold' strategy, holding on to their stocks through thick and thin, whether the stock market is moving up or down.
I used to be one of them until I realised I lost out on a lot of opportunities by not selling out when markets were high and buying back again when markets were low. We do have to be mindful of opportunity costs. In the last bear market from March 2000 to March 2003, I also observed that when the tide turned, almost all stock prices went down, including blue chips.
Let me give an example: DBS Group Holdings' share price was as low as $8 in 2003; it hovered between $8 and $10 for close to one year. If you practised market cycle investing, and even if you had missed the bottom, you could have easily bought the bank's shares at about $10.
In 2007, after four years of bull runs, DBS' share price shot up to as high as $25 and hovered between $20 and $25 for more than one year.
Again, even if you missed the top, you could have easily sold DBS shares when the price was about $20. By buying at $10 and selling at $20, you would have easily pocketed a 100 per cent return over four years. Not bad at all.
Similarly, by practising market cycle investing, after selling out at $20, and after one year of a bear market, you can now easily buy back DBS shares at less than $10 again.
On the other hand, if you had bought DBS shares at $10 in 2003 and steadfastly held on to them through 'thick and thin', you would have basically enjoyed the 'roller-coaster ride' of the market but would have no profits to show after five years.
Of course, nobody knows when the market will bottom. My experience is that I was early and invested all my money by early 2002. However, I was one year too early as the Singapore stock market bottomed only in March 2003.
Despite missing the bottom by 12 months, I still managed to achieve over 200 per cent in returns riding the four-year bull market that followed.
Thus, by practising market cycle investing, one would inevitably buy when prices are low, and sell out when prices are high.
By doing so, you have also reduced your risks of losing money.
Big investor but frugal spender
By Lorna Tan
Despite being a multimillionaire, entrepreneur-cum-motivational speaker, Adam Khoo still hesitates before spending on consumer products like his iPhone.
However, when it comes to investments, the founder of Adam Khoo Learning Technologies Group wouldn't even think twice when investing, say, $50,000 in stocks. This is because stocks are expected to potentially generate more money, he says.
A conservative and long-term investor, he prefers to invest in cash-rich, large-cap companies that have low debts and the potential to consistently increase their earnings.
His group, which focuses on education, comprises 16 firms in seven countries with an annual turnover of $15 million. He also took over his father's advertising firm, Adcom, in 1999.
A business administration degree holder from the National University of Singapore, Mr Khoo - who is all of 34 - is also known for his motivational books. Last month, he launched his ninth book, Profit From Panic, which gives practical tips on how to deal with the current economic crisis.
He is married to Ms Sally Ong, 38, who is a director at one of his firms. The couple have two daughters - Kelly, five, and Samantha, three.
Q: Are you a saver or spender?
One of the factors that helped me build up my wealth over the years is that I am relatively frugal.
I have always saved at least 50 per cent of my income and I don't believe in spending a lot of money on luxuries. I buy clothes once a year only when I'm in Bangkok or Indonesia. Usually I visit a shop for half an hour and pick up 10 shirts and trousers at one go. I am a person of simple taste, except when it comes to cars. I like fast cars.
I invest 100 per cent of my savings consistently. But when the market gets too overvalued, I hold a larger proportion in cash as a precautionary measure.
Q: How much do you charge to your credit cards each month?
I have three credit cards but I use only one regularly for my personal expenditure. I chalk up about $2,000 to $3,000 every month. I use my credit card instead of cash whenever I can for easy tracking purposes. I withdraw about $200 from the ATM each time.
I pay my credit card bill every month and if I get charged 10 cents for late payment interest, I will scream. I don't believe in paying the annual fee too and will ask the bank to waive it.
Q: What financial planning have you done for yourself?
My portfolio, which I manage myself, is made up of the following investments: property that I rent out, private businesses, Singapore stocks, US stocks and exchange- traded funds (ETFs). My investments have generated an average return of over 20 per cent per annum.
Currently, I have about US$400,000 (S$611,000) in US stocks, such as Boeing, Google, Nike, Pepsico, and ETFs, and another $400,000 in Singapore stocks, such as CapitaLand, OCBC Bank, the Singapore Stock Exchange, Bestworld and STI ETF.
When it comes to insurance, I believe in buying term and investing the rest. Still, I bought seven traditional plans such as whole life and endowment when I was young, because my wife is a former AIA agent and I had bought them from her. About four years ago, I bought a term with cover of $1 million which brings my total life cover to about $2 million.
Q: What property do you own?
In 1998, I bought a 1,300 sq ft condominium in East Coast for $480,000 and rented it out for about $3,000. I sold it for $650,000 in 2004.
I also have a 5,000 sq ft semi- detached house in East Coast which was bought four years ago for $1.3 million.
Early last year, I bought a 900 sq ft condo at Robertson Quay for $1.3 million. I'm renting it out at $4,000.
Q: Moneywise, what were your growing-up years like?
I come from a wealthy family where my father and uncles are savvy business people and investors. That background influenced my values, beliefs and attitudes towards the possibility of building immense wealth when one is prepared to work hard and educate oneself.
My father started his advertising firm Adcom in 1972 and mum was editor of the women's magazine, Her World. I was the only child. We lived in a bungalow in Changi.
However, what gave me the drive to build my own wealth and to value money is that my father is an extremely frugal man, and that rubbed off a lot on me. In those days, my dad would not even buy a brand-new car despite his wealth. He would compare prices of toilet paper and toothpaste all over the supermarket before deciding what to buy.
Q: How did you get interested in investing?
Every Chinese New Year, from the time I was 15, my grandfather would give me hongbao with cash plus Malaysian shares like Genting, Kuantan Flour Mill and Hicom.
When I was in the army, I started dabbling in shares.
At about that time, I was inspired by a book I read, Buffetology, based on the success and work of Warren Buffett. I was amazed by a man who was able to build his wealth purely through investing.
Q: What's the most extravagant thing you have bought?
A $230,000 red Lotus bought last October. It's a reward for myself.
Q: What's your retirement plan?
My passive income from book royalties, dividends and business profits is enough to cover my expenses so, technically, I can stop working if I really wanted to.
Q: Home now is...?
I live in the semi-detached house in East Coast.
Q: I drive...?
A red Lotus Elise and a red BMW convertible.
This article was first published in The Straits Times.
