Sunday 14 June 2015

Index Funds, a great way to begin your investment journey

Many of my friends new to the scene of investing often ask what they should invest in, something that would have lower risk and a higher return than say, bonds or current inflation rates. Without hesitation, I would recommend index funds. Why, we might ask?

Well, we know statistics had proven that most fund managers of active funds failed to beat the index returns over a certain period. Managers of active funds as the name suggest, actively manages the fund portfolio by selecting stocks which he thinks will beat the market. Often, such funds have higher fees that passive funds which usually track the general market. Definitely then, we can say why not we invest in fund managers which had beaten the market? One thing is that, history may prove a useful tool to gauge a manager’s performance, but the future performance might not be similar in many ways. This could be due to the manager’s lucky streak of being in the right industry at the right time, and this may or may not be due to the well-timed anticipation of the manager.

So, we are pretty well off investing in funds which track the index itself (passive funds), producing market returns which would be enough to beat inflation eroding our wealth. So where do we start?

Well, in Singapore, we have the popular Straits Times Index (STI) ETFs. ETFs are exchange-traded funds. They track all kinds of popular assets; gold, oil, forex and indices etc. For Singapore index funds, there are the SPDR STI ETF and the Nikko AM STI ETF. They are both listed in the Singapore Exchange (SGX) are can be traded like stocks. Both ETFs are good in their own ways, but I would prefer SPDR STI ETFs now that the SGX have already reducing the minimum board lots since Jan 19. The initial advantage Nikko AM STI ETF had over the SPDR STI ETF was that Nikko could trade in lower board sizes of 100 shares, but since the board lots have been reduced across the board, it is now a much clearer choice. In addition, the SPDR STI ETF has a lower expense ratio, which measures the amount of fees the manager charges for managing the fund, aka adjusting the portfolio in order to track the market index as close as possible.

The minimum commission to trade STI ETFs apply though, which is usually $25 for most brokerages. This could be very hefty for small investors looking to only invest say a few hundred bucks into the ETF every month. In which case they can look to many products in the market which allows regular investments into ETFs, such as the POSB Invest-Saver, the OCBC BCIP and POEMS Share-Builder. For more in depth details on these plans, you could refer to the below link.

However, the average total cost will be much higher than buying directly from SGX, but it would be very useful for retail investors looking to invest only a few hundred dollars regularly every month. For new investors, this would be a good way since it allows dollar-cost averaging, which eliminates the risks due to market timing.

But there could be an even better way to do dollar-cost averaging, contributing regularly while enjoying the lower costs of buying directly from SGX. Let me present you...

Yes, the no minimum commission works wonders here for the regular small time investor, and could prove to be a very useful tool, provided one has the discipline to continue to buy the ETF regularly, irrespective of the market sentiments at the time. I know there are many people out there who can be easily spooked by market events which deviates them from regularly contributing to the fund.

So which will you choose? The choice is up to you...

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