I recently attended a Singapore Investment Week seminar which included a talk on investing using Robo-Advisors. Their argument is a compelling one. Why use fund managers who are shown to underperform (over the long term), yet when they do poorly, you still pay them a fee regardless? Stocks go up and you pay their fee. They go down, and you also pay. And their fee can be very high. Robo-Advisors also have fees, but they’re typically about one-quarter of the fees for a mutual fund/unit trust. But there is another option that could be even better, one in which I personally use.
Sorting Good Advice from Bad
“You want to know what the best [financial market] investment is?”, an elderly man named Lyle once asked me. “Index funds,” he proclaimed. “Just put a certain amount of money into them at fixed intervals (dollar-cost averaging) and never worry about market movements or market crashes. Over the long term, your gains will be the same as the overall market gains.”
I was in my early 20s and had left the Bay Area (in the States) to move to a remote rural retirement community. Living among a small population with much older individuals was at first a huge adjustment. Everyone called me “kid” and gave me advice, often unsolicited.
But this particular advice proved to be very useful. The man who told me this was himself very, very wealthy. And he wasn’t trying to sell me anything. These, by the way, are two important considerations I use to sort out good advice from bad – are they themselves living examples of the advice they’re giving, and do they benefit financially from their advice?
He said he had invested in index funds way back in the 1970s, and unlike most of his friends who bought and sold stocks or unit trusts, he over time had much more gains than they did. He also had a lot more free time, not having to check up on the markets. And perhaps a lot better sleep, without having to worry the markets.
His friends on the other hand, tried to time the market. They would try to stay current on news about interest rates, unemployment rates, and other economic indicators. Their aim was to buy low and sell high. They assumed they were smarter and savvier than the masses, since a buy-low-sell-high strategy implies that you’re smarter than the people you are selling to/buying from because those people are making the opposite bet.
Lyle didn’t have the patience or time so he ignored all of this, and just went with passively managed index funds. What he said made sense so I decided to try it. Because they’re passively managed, index funds have very low fees. The ones I bought nearly 20 years ago had an expense ratio of 0.04% to 0.1%. And after nearly two decades, which included one ginormous market crash, I can attest that he was right.
Are Annualized Market Returns Really as High as 9%?
We often hear that you can make >9% (annualized return) if you invest in the stock market. This benchmark figure comes from the S&P 500 Index. The S&P is based on the market capitalizations of 500 large companies having common stock listed on the New York Stock Exchange. Over a 20-year period (from 1994 to 2013), the S&P annualized return was 9.22%… BUT
This assumes you were invested in all 5027 trading days.
If you missed just the top 20 trading days (just 20 days over a 20-year period), your return would have been just 3.02%. Miss the top 40 days (out of 5027) and your return is negative.
This is why most people, including professional and highly-paid fund managers (more than 90% over a 15-year period) underperform the S&P 500 Index.
There just isn’t some crystal ball or secret trading technique that can forecast the best performing days. And anyone who tells you they have the secret, is either lying, ignorant, or is just in their first few years of trading. Timing the market consistently year on year is extremely difficult, yet because of its potential for high returns, it can be very tempting.
That temptation however can get you in trouble. But index funds just passively track an index. That’s what makes them so easy. The investment securities are not chosen by a portfolio manager, but instead are automatically selected to match an index or part of the market. You don’t have to time the market. You stay invested in all the 5037 days. An alternative passively managed investment instrument is the ETF, which also has low expenses.
Why I Don’t Use Robo-Advisors
Robo-advisors also use passively managed funds from large financial firms for their investor portfolios. But they’re essentially an extra layer, and that layer comes with a fee. They do add value by choosing an index fund for you and periodically rebalancing your portfolio.
Investing directly in passively managed funds is simple. So is periodically rebalancing a portfolio. An investor with even a small amount of financial knowledge can save the extra layer of fees (this can amount to an annual savings of $3 to $7 per $1,000 invested).
Why I Don’t Write Much About Investing
Look at any personal finance blog, and you’ll likely see two things they all have in common. (1) They over-emphasise investing and (2) they sell credit cards/loans or insurance. Many of these blogs make money by selling you insurance or debt (credit cards/loans), or by advising you on what investment/investment aid to purchase (that a financial institution pays them to write about).
I don’t write much about financial market instruments (such as stocks, bonds, unit trusts, options, etc.), because I believe the vast majority of people can benefit from simple, commission-free strategies, such as having an emergency fund and proper insurance (you can buy direct to save on commission), maximising your CPF, and paying off your debt (including your mortgage debt). These things (which I also consider investments) are not nearly as risky as playing the market. But many financial advisors and bloggers won’t talk about these things because they do not benefit financially from it. Their end goal is to make money and stay solvent. So the advice they provide must stay aligned with this end goal.
Once you take care of all your debt (including your home), minimise your financial risks (through insurance and having an emergency fund) and fund your retirement, you can consider other things to do with your money. But don’t limit yourself to only financial market instruments. You can also invest in real assets, fixed deposits, and government bonds (such as the Singapore Savings Bond).
And one often overlooked thing you could invest in is yourself. Take some courses to upskill, join a gym, buy healthier food, travel and explore. There are all sorts of ways to improve yourself, and some are income-generating. Afterall, you are your biggest winning investment.