Personal finance
COMMENTARY
Understanding investment strategies
In the third of a four-part series
on financial planning for different
life stages, we turn our attention
to investment for working adults.
BENEDICT KOH
I nvestment is a critical component of
personal financial planning. It requires
you to postpone current consumption and
invest savings in investment instruments
to grow your wealth. Through investments,
you are accumulating the necessary finan-
cial resources to finance your future goals
such as purchasing assets (car or house) or
financing your children’s education.
Furthermore, with increased life
expectancies, the average person is ex-
pected to spend close to 20 years of his
life in retirement. This implies that you
will need substantial savings to support
a comfortable retirement. It is, therefore,
crucial that you start saving early and
regularly, and investing these savings
while you are gainfully employed.
Investment strategies
for growing savings
The key drivers of wealth creation are: The
initial amount of capital for investment,
return earned on various instruments and
holding period of investment, as illustrat-
ed in Table 1. What is obvious from these
three investment strategies is that for
wealth accumulation to take place, indi-
viduals must: A) invest sufficient amounts
of savings during their working years; b)
invest as early as possible; and c) invest
in high-yield instruments.
The results in Table 1 may tempt you
to invest only in high-return investment
instruments, but beware that such instru-
ments come with a high risk. This means
that there is a chance that you may lose
part or all of your capital from such risky
investments.
The appropriate choice of investment
instruments depends on both your goals
as well as your risk appetite. Only if you
have an appetite for risk and can afford to
take losses should you invest in high-risk
investments. For example, elderly inves-
tors who have school-going dependants
and are near retirement should avoid
high-risk investment instruments.
Asset allocation
Inexperienced investors often look for a
single successful investment to grow their
today Saturday November 26, 2011 33
tends to diminish, which in turn affects
your asset allocation. For example, inves-
tors who are in their 20s and have no
dependants may aim to grow their wealth
as quickly as possible. Consequently, they
may wish to invest a higher proportion of
their savings in stocks.
As they move into their 30s and 40s,
they should be more prudent and shift
more of their investments into high yield
corporate bonds and money market funds.
Table 2 shows some possible asset alloca-
tions for investors in different age groups.
Besides age, asset allocation also
depends on the risk appetite or risk tol-
erance of the investor. If you are very
risk-averse, then you should invest a sub-
stantial portion of your savings in low-
risk instruments such as deposits and
bonds. On the other hand, if you are able
to take more risk, then consider investing
more of your savings in equities or equity-
linked instruments such as unit trusts,
commodities and hedge funds.
Since investors have different goals,
financial circumstances as well as risk ap-
petite, they must engage financial advis-
ers to perform fact finding, needs analysis
and risk profiling before customising an
asset allocation that suits them.
Consistent saving and investing re-
quires a lot of discipline. Therefore, it is
important to learn such virtues at a young
Artwork by Yen Yok
age and continue with this habit well into
Table 1: Investment Strategies adulthood. The earlier you start saving
Strategy 1 Strategy 2 Strategy 3 and investing, the more likely you will
succeed in growing your wealth.
Amount of investment S$200 S$500 S$1,000
Sound and prudent investing al-
Years of investment 5 15 25 lows you to enjoy the standard of living
Return on investment 1% 5% 10% that you desire. Seldom do people attain
their goals and desired standards of living
Accumulated wealth S$12,300 S$133,644 S$1,326,833 through luck. They must commit their
savings to investment to achieve them.
Another reward of sound investment
Table 2: Asset Allocation Across Life Cycle of Investor
is the accumulation of substantial wealth
Age Financial goal Risk appetite Stocks Bonds Deposits to cushion you against financial disasters.
20-30 Grow capital High 70% 25% 5% Should you be struck with prolonged ill-
31-50 Protect family Moderate 50% 30% 20% ness or experience retrenchment, your
accumulated wealth will tide you over
51-60 Build nest egg Low 10% 60% 30% such challenging episodes in your life.
Most importantly, you would have
wealth. These are the ones who wished include deposits, bonds, equities, proper- accumulated a significant nest egg for
that they were able to identify stocks ties; and other alternative assets such as retirement. This will allow you to enjoy
such as Google or Microsoft which saw commodities, hedge funds, structured your golden years without the distress of
their initial public offering (IPO) prices products, etc. having financial problems. ¢
appreciate multiple times over. Asset allocation is a form of diversi-
Such strategy of betting on one stock fication since deposits and bonds are not Dr Benedict Koh is a professor
or investment is highly risky and not rec- highly correlated with equity and proper- of finance and the director of the
ommended. Finance researchers tell us ties. By including lowly correlated asset Centre for Silver Security at Singapore
that a key determinant of returns from classes in your portfolio, your investment Management University. This article
investments is asset allocation, which risk can be reduced significantly. is drawn from Personal Investments
refers to the mix of asset classes that you Your asset allocation should also vary by Benedict Koh and Fong Wai Mun
select in your portfolio. These assets can with age. As you age, your risk appetite (1st Edition, Prentice Hall 2011).