Draft Basics of Investment 2005 Contents Draft When

Draft Basics of Investment 2005

Contents Draft When to Invest Establishing Personal Investment Policy Return and Risks Horizon and Liquidity Example - Policy Summary Appendix

Setting up Priorities 1. Savings for Emergencies 2. Insurance Cover (accidents, medical, life) 3. Investment Draft

Traditional Investment Draft Ø Cash – Liquid Assets, pay interest – Eg. Short term deposits, Treasury Bills Ø Bonds – Fixed Income Instrument, pay coupons (or interest) – Eg. Government Bonds, Corporate Bonds Ø Stocks – Shares in companies, pay dividends – Eg. Microsoft shares , IBB shares

Which Ones to Buy ? Draft Ø Stocks have generally outperformed at some point or another, hence have received quite a lot of attention. Ø Microsoft Shares? Tech Stocks? Value Shares? Biotech? Growth Stories? Ø Long term bonds? Munis? Asset Backed? Ø Lots of Questions – Need Lots of Answers?

Answer : Ø Depends on your Goals Age Asset Size and Risk Tolerance …. Draft

Contents Draft When to Invest Establishing Personal Investment Policy Return and Risks Horizon and Liquidity Example - Policy Summary Appendix

Setting up Investment Policy 1. Return Objective (Goals) 2. Risk Tolerance Subject to ; a. b. c. d. e. Time Horizon Liquidity Requirement Laws & Regulations Taxes where applicable Unique Needs Draft

1. Return Objective (Goals) Ø Finding the right Return Objective – Eg. To double your money in 10 years. – Steady return over long periods of time – To get $1, 000 in 30 years – To get $100, 000 in 6 years – etc Draft

Draft Data From 1926 -2001 Asset Type Average Return per year Large (Blue Chip) Stocks 10. 7% Small Stocks 12. 5% Long Term Corporate Bonds 5. 8% Long Term Government Bonds 5. 3% US Treasury Bills (Cash) 3. 8%

Return in US Stock Market Eg. US Stock market investment of US$100 in Dec 1981 S&P 500 1981 $100. 00 1993 $380. 62 1982 $114. 76 1994 $374. 76 1983 $134. 58 1995 $502. 59 1984 $136. 47 1996 $604. 44 1985 $172. 40 1997 $791. 86 1986 $197. 61 1998 $1, 003. 04 1987 $201. 62 1999 $1, 198. 90 1988 $226. 62 2000 $1, 077. 34 1989 $288. 37 2001 $936. 83 1990 $269. 46 2002 $717. 93 1991 $340. 34 2003 $907. 32 1992 $355. 54 2004 $988. 92 Draft

Draft Investment in US Stock Market US$100 Investment in December 1981 turned to a handsome US$988 in December 2004

S&P Monthly Returns of US Stocks have been Volatile Draft

Draft • Source : Stocks, Bonds, Bills and Inflation 2002 Yearbook

Setting up Investment Policy 1. Return Objective (Goals) 2. Risk Tolerance Subject to ; a. b. c. d. e. Time Horizon Liquidity Requirement Laws & Regulations Taxes where applicable Unique Needs Draft

2. Risk Tolerance • Setting Return Objectives needs Risk Parameters – No pain No gain : No risk No Return • What Risk to assume? ? Draft

Draft Investing in Shares of Companies Ø Risks in Investing in Shares of Companies – Specific Risk (companies can be unprofitable and at worst can go bankrupt) – Sector Risk (share price can also fall following the same companies within the same sector) – Market Risk (share price of a company can also fall with the rest of the stocks in the same market) Ø These risks need return compensation. Sometimes you are well compensated, other times you are not. Ø Solution : DIVERSIFY, across many stocks, many sectors, many markets. Ø Simpler solution : BUYING INDEX FUND

Draft Return and Risk US Equity US Bonds Historical return of various asset classes against the risk (annualized) Sources : Various

Draft Diversification : Combining Assets Benefits of Correlation between asset classes Stocks and Bonds rises and falls at different times

Setting up Investment Policy 1. Return Objective (Goals) 2. Risk Tolerance Subject to ; a. b. c. d. e. Time Horizon Liquidity Requirement Laws & Regulations Taxes where applicable Unique Needs Draft

a. Time Horizon Draft • Risk and Return objective usually have different parameters depending upon time horizon of the investment • Age plays an important role for individuals. • Example Return Objective of Setting a Retirement plan (at the age of 55) – A person who is 25 for instance, will have a different set of risk tolerance compared to another who is already 48 years old.

Phases of Life Draft

Setting up Investment Policy 1. Return Objective (Goals) 2. Risk Tolerance Subject to ; a. b. c. d. e. Time Horizon Liquidity Requirement Laws & Regulations Taxes where applicable Unique Needs Draft

b. Liquidity Requirement Draft • Again, Risk and Return objective usually have different parameters depending upon Liquidity Requirement from the investment fund – Example, the need of a regular income as opposed to one lump sum payment – or the need of a big payment (example a new house) at age of 40. This liquidity requirement has to be incorporated when we set up the portfolio

Setting up Investment Policy 1. Return Objective (Goals) 2. Risk Tolerance Subject to ; a. b. c. d. e. Time Horizon Liquidity Requirement Laws & Regulations Taxes where applicable Unique Needs Draft

Other Considerations • More Diversification – Alternative Asset Classes • Other Risks – Currency, Country, Counterparties etc • Regular Investments versus Lump Sum Investment Draft

More Diversification Draft Ø Spreading your risk - by investing in a variety of assets to protect your overall investment without sacrificing too much of expected return. Ø Need to find the optimal diversification mix from a variety of instruments available subject to again your age, asset size, tolerance for risk and investment goals.

Draft Various Asset Classes and the Risk Profile

Currency Risks Draft Ø Studies have shown the following • Expected Returns of Equity Investments are generally expected to be high. Much higher than the currency risks • Bond Investment Return on the other hand tends to be more moderate and as such, currency risk may be more pronounced Ø Currency Management may prove important in a diversified portfolio. More importantly are the goals of the fund

S&P 500 index US$ vs SGD$ • Draft During 1982 -2004 SGD$ fell 20% against US$. Investing in US Stocks during the period earned 11% p. a. in US$. In SGD$ term, return is 10% p. a.

Contents Draft When to Invest Establishing Personal Investment Policy Return and Risks Horizon and Liquidity Example – Mr Ash Burn Summary Appendix

Draft Investment Policy Example : Mr Ash Burn 1. Return Objective (Goals) : Wishes to have monthly income of US$5, 000 at the age of 56 - for 24 years Wishes to travel a lot when retired, US$ requirement not a priority 2. Risk Tolerance Medium to High Risk (Age is 24 earning US$2, 000/mth 5% increment/year) Don’t really mind currency risk – Wish to have multi currency exposure Subject to ; a. Time Horizon - 31 years to go before 1 st Payment b. Liquidity Requirement - No real need of liquidity from this investment fund c. Laws & Regulations - US law & regulation applies d. Taxes where applicable - No tax concessions

Investment Strategy Example : Mr Ash Draft Burn Based on the policy set in the previous slide example recommendation for Mr Ash Burn is as follows; Allocation Expected Return Volatility US Equity Index 20% 9. 2% 21. 7% Developed Market Equity Indices (non-US) 30% 6. 3% 18. 9% Emerging Market Equity Index Fund 20% 11. 1% 27. 9% Private Equity Fund 15% 19. 0% 20. 0% Long term Fixed Income Funds 15% 1. 2% 6. 5% 100% 9. 0% 12. 0% Total

Investment Requirement Draft Given 9% Annual Return Expectation, Mr Ash Burn will need to come up with either – a lump sum investment amount of US$ 40, 753, or – an annual investment of US$ 3, 615 ($301/mth)

Investment Requirement • Draft If Return Expectation is more moderate 6. 5%, need; – a lump sum investment amount of US$ 103, 896, or – an annual investment of US$ 7, 390 ($616/mth), Or an even better (less painful alternative) • $4, 885/year (but increasing this payment by 5% per year), hence monthly installment will be $407 on the 1 st year, $427 in the 2 nd year, and so on and so forth. At 52 for instance, he will be paying $956/mth. Perhaps this will be an easier option as he is assumed to earn more as he grows older

Policy Review – Mr Ash burn Draft v 1 year later, the investment policy is reviewed v Return expectation may change, or his risk appetite may change, or he suddenly decides he wants to incorporate a mansion when he is 60 and is willing to receive less monthly annuities v All of which will require a different investment strategy and hence different monthly installments

Contents Draft When to Invest Establishing Personal Investment Policy Return and Risks Horizon and Liquidity Example - Policy Summary – 4 Key Points Appendix

4 Key Points Draft 1. Set up Investment Policy - Return & Risk goes hand in hand ´ Avoid “get-rich-quick-and-no-risk” schemes 2. Regular Review of Investment Policy ´ At least once a year ´ Adjust Risk Lower Towards Maturity 3. Regular Investments ´ Avoid the need to time market ´ Entry points are averaged over the long run ´ Painful lump sum investment can be avoided 4. Diversified Portfolio ´ Fund Type Investments generally simpler ´ Avoid the pain of being hit by specific risks