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The Peaks and Troughs of Investments

09 Nov 2017 
SOURCE: CPF Board

​By Soh Chin Heng

 

Mr Soh Chin Heng is the Deputy Chief Executive (Services) of the Central Provident Fund Board Singapore and a non-practising certified financial planner. He gives talks and writes regularly on CPF and financial security. The stories shared in this series are based on real life experiences, suitably anonymised to preserve confidentiality.

 

Edison started investing in the year 2000.

 

The last couple of years in the twentieth century were extraordinary years for dotcom companies. Any initial public offering remotely connected with the internet made handsome gains for the shareholders, regardless whether the company made profits or not. The technology-heavy American stock index NASDAQ[1] went on a gravity-defying trajectory, with each pullback a chance to buy when it dipped. The dawn of the twenty-first century was greeted by the sensational news that a dotcom company - America Online - had swallowed up the blue chip Time Warner. Edison remembered that.

 

Edison had worked a few years, and had accumulated some savings. He was interested to grow his savings. Stories after stories of investors making big bucks from technology stocks whetted his appetite. He made his first investment in a global technology unit trust in January 2000. Imagine his thrill when his investment grew 20% in one month! Immediately, the second investment went in, and the fund grew another 10% the next month. And the third, and then the fourth.

 

Edison couldn't have timed his investments any worse. The NASDAQ plunged soon after, and did not recover for a long time. He was stunned like vegetable; it just seemed so unreal. He watched, first the profits and then his capital vanished until his investments became almost worthless. He wanted to cry, but couldn't.

 

The cardinal rule in investments is not to invest in what you do not understand. Investing is a complex issue. Besides investment know-how, you need to have the temperament to be able to handle the roller coaster feeling as your investment value goes up and down.

 

One of the most important investment decisions you need to make is your asset allocation. The myriad of investments can be broadly classified into two asset classes – stocks and bonds. When you invest in stocks, you are investing as a business owner.  This means that you take the risks and rewards of the business through the ups and downs of the business and economic cycles. When you invest in bonds, you are a lender of capital and you worry if the borrower would pay you the interest due to you and eventually, return you your capital.

 The Peaks and Troughs of Investments 1.png

The key difference between stocks and bonds is the return-risk characteristics. Return, in simple terms, is like the interest you get from a savings account or a fixed deposit. It is a measure of how fast your money is growing. Risk is the yo-yo effect you experience as the price of your investment goes up and down, and is a measure of the volatility of the investments. Stocks are generally high-risk and high-return, and bonds low-risk and low-return.

 

Your asset allocation is the proportion of assets you put into bonds vis-à-vis stocks. And the general guideline is that you can have a greater proportion of your assets in stocks when you are younger, as you have a longer time frame to ride out the peaks and troughs of the stock markets. A simple rule of thumb is to use your age as your allocation in bonds. Studies have shown that your asset allocation is the main determinant of the success of your investment.

 The Peaks and Troughs of Investments 2.png

This article is part of a series by Mr Soh, who will be sharing tips on how you can chart your way towards financial security. Read more:

The Most Important Financial Question

Your Financial Security Compass

Your Lifetime Financial Partner

Albert Einstein and Warren Buffet

My Three Generational Story

The Mountain of Debts

A Most Wonderful Emergency Fund (For Some)

The Valley of Risks

 

[1] National Association of Securities Dealers Automated Quotations

 

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