Sunday, 29 December 2013

Who Says You Can't Beat the Index?

Numerous academia and literature have impressed upon us that active investors like us cannot beat the index. This large no. of academia and literature cannot be wrong. Nevertheless, after reviewing the returns of the Straits Times Index (STI) over the past 26 years, I have an inkling that we might be able to beat the index after all. 

Over the past 26 years from Jan 1988 till Nov 2013, the returns of the Dow Jones Industrial Average, Standard & Poor's 500, Nasdaq Composite and Hang Seng Index have averaged (computed as geometric average) about 8.5%, 7.8%, 10.0% and 9.3% respectively. The returns of STI, in contrast, averaged about 5.0%, similar to FTSE's return of 5.2%. The only index among those studied that performed worse than STI is the Nikkei index, which returned -1.6%. At a return of 5.0%, it should not be difficult in beating the index. 

To understand the poor performance of STI, I collected the price of the 30 component stocks of STI (the prices are available only from 2000 onwards from Yahoo! Finance) and computed their individual performances. It turned out that on an equal-weighted basis (i.e. all component stocks have equal weights in the index), the return since 2000 is actually much higher, at 9.7% compared to 3.9% for the STI. See the table below for the computation. (Note that there are gaps in the prices due to corporate actions. For example, SPH, prior to Jun 2004, was priced around $20. After a 5-for-1 stock split, the price became around $4. The data from Yahoo! Finance only recorded the price after the stock split but not before. Nevertheless, it does not significantly affect the conclusion below.)

Returns of STI Component Stocks (Without Dividends)

The reason for the lower performance of STI is because stocks with higher market capitalisation are given higher weights in the index. The 10 stocks with the highest weights are namely DBS, OCBC, Singtel, UOB, Keppel Corp, Jardine Matheson, Jardine Strategic, Genting Singapore, Global Logistics Properties and Hong Kong Land in that order. These stocks have a total weight of 65.7% in the index. If we consider only the first 4 heavyweight stocks (namely, DBS, OCBC, Singtel and UOB), which have a combined weight of 40.9%, their return since 2000 is only 2.9%. This pulled down the performance of the rest of the STI component stocks.

If we include dividends, the results would be similar. The average return of STI is 6.7%, which is slightly less than that of the 4 heavyweight stocks of 7.5%. In contrast, the average return for a portfolio of equal-weighted STI component stocks is 14.1%.

Returns of STI Component Stocks (With Dividends)

Thus, a simple way of beating the index is to construct a portfolio of equal-weighted STI component stocks. Considering dividends, this will return 14.1%, more than double the returns of STI of 6.7%. Alternatively, by omitting the 4 heavyweights of DBS, OCBC, Singtel and UOB, the portfolio will return an even higher 15.4%. On a dollar basis, over the 13 years since 2000, a $10,000 investment in STI with dividends reinvested would become $23,235. An equal-weighted portfolio of all STI component stocks would become $55,554. An equal-weighted portfolio of STI minus the heavyweights would become $64,369. So, who says you cannot beat the index?

Wish everybody a Happy, Prosperous and Healthy 2014!

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Sunday, 22 December 2013

Wealth Management Lessons from the Railroad Tycoon

It is rare that computer games have lessons to teach us, but the Railroad Tycoon has a number of lessons in wealth management to offer to us.

First of all, let me introduce what the Railroad Tycoon is all about. It is a game in which you set up a railroad company and build railroads linking cities and resources together and transporting resources among the cities. There is an objective for each game, which could be to achieve a certain wealth or connect 2 far away cities together by a certain year. 

Building Rail Roads and Transporting Resources among Cities

Besides building railroads and scheduling trains to run, Railroad Tycoon also has a stock market of all the railroad companies. Personally, you can buy and sell shares, including on margin. As the executive Chairman of your railroad company, you can also issue new shares or bonds or buy back them.

Stock Market in the Railroad Tycoon

To keep the stock market realistic, Railroad Tycoon keeps a record of the company's balance sheets, income statements and cashflow statements for the past years. Here, you can carry out a financial analysis of the company if you wish.

Balance Sheet of the Company

Income Statement of the Company
Financial Statement of the Company

The reason why Railroad Tycoon has wealth management lessons to offer is because you play the executive Chairman of the company, where you can make all the decisions from running the company to deciding what to do with the company's funds. So, it offers a glimpse of how companies in the real world are run. Here are some of the lessons I got from playing the Railroad Tycoon.

Lesson #1: To Be Successful in the Stock Market, Your Company Must First Be Well Run

To achieve the objectives in some games, it is necessary to play the stock market, such as buying shares on margin, attempting merger with a rival railroad company etc. However, in order to be successful in the stock market, it is important to be successful as a businessman first. If your railroad company is not well run, its share price will languish and you will face margin calls from the brokers. Conversely, if the railroad company is well run, its share price will increase, offering you greater margin to buy more shares of your own company or that of others.

Lesson #2: Boring Companies Can Be Very Profitable

In the game, besides transporting the resources produced by companies, you can also invest in them using the railroad company's money. So, the more resources you transport from that company, the more profitable it is. Boring companies, such as grain mills, cattle yards, sheep farms, etc. can actually be very profitable. The resources they produce do not need to undergo many processes and hence it is easier to make large profits from them. For example, you just need to transport the grains from the grain mill in City 1 to the bakery in City 2 to produce food for the people in City 3. 

In contrast, "high-tech" companies (the game era can be as early as 1850s) like steel mills requires more resources and processes. It requires both coal and iron ore to produce steel to be manufactured into goods for the people. So, you need as many as 5 cities with the required resources to deliver the finished products. It is more difficult for the steel mill to be profitable.

Lesson #3: If One Company is Profitable, All in the Vertically Integrated Chain Can Be Profitable

From the previous section, you can see that companies can be vertically integrated together. By successfully integrating the related companies together (e.g. grain mill + bakery, or coal mine + iron mine + steel mill + tool & die factory) through the railroads and train services, all can be very profitable at the same time.

Lesson #4: Share Buy-Backs are Independent of Price

As an outsider in the real world, we often think that companies engage in share back-buys because they think that the share price is too low and does not reflect the actual worth of the company. In Railroad Tycoon, if your company is profitable, you can engage in share buy-backs as well. However, it is not always when the share price has fallen below the actual value when I engage in share buy-backs. I do so when the share price has fallen and there is increased risk of margin calls from the brokers. At other times, it might be to buy out the other shareholders using the company's cash. Sometimes, the company might be so profitable and you just want to get rid of the excess cash. So, even if the share price is on a high and there is no risk of margin calls, I would engage in share buy-backs. The share price does not really affect when I engage in share buy-backs. In fact, the higher the share price, the easier is the task of spending money! So, share buy-backs do not necessarily mean that the share price is low.


As small-time investors, we often do not know how companies in the real world are run. The Railroad Tycoon offers a chance to be the executive Chairman of a company. While not fully reflective of the real world, you get some valuable insights into how companies are run.

Wishing everybody a Merry Christmas :)

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Sunday, 15 December 2013

Deciding How Much Tax You Want to Pay

It is the time of the year when you start to see newspaper articles and blog posts extolling the virtues of contributing to the Supplementary Retirement Scheme (SRS). SRS is part of the overall tax planning when you list down your incomes and personal tax reliefs for the year to estimate how much tax you need to pay in the next year. It is like seeing your tax bill 6 months in advance. But the advantage is that this tax bill is not finalised yet. If you don't like the tax amount shown, you could still explore ways to reduce the amount. 

Tax Planning for Yourself

Below is a screenshot of the tax calculator downloaded from IRAS' website

Tax Calculator to Decide How Much Tax You Want to Pay

Here, you could see all the possible personal tax reliefs that could be claimed. You could run through each of them to see whether you are eligible for it. The hyperlinks in the tax calculator links you to an explanation and the eligibility conditions for each of these tax reliefs. If you find that the estimated tax amount is too high for your liking, then you might want to consider additional tax reliefs, such as CPF cash top-up relief and SRS relief. However, to be eligible for these reliefs, you will need to incur some expenses or contribute some money first. For example, to be eligible for the parent tax relief, you will need to incur at least $2,000 to support your parents. To qualify for CPF cash top-up and SRS reliefs, you will need to contribute some money into them.

CPF cash top-ups can be a good way of supporting your parents, especially if they are over the monthly drawdown age of the CPF Minimum Sum Scheme (ranging from 60 to 65 years old). You can top-up their CPF accounts using cash either via a lump sum or monthly contributions and be eligible for the CPF cash top-up relief while they can receive monthly payouts from CPF. Whatever money still kept in the CPF attracts an interest rate of 4%, which is very attractive compared to today's low interest rates for bank savings.

Notwithstanding the above, it is not necessary to contribute the maximum towards CPF and/or SRS to fully maximise the tax benefits. Contribute what you can afford and it will go some ways towards saving some money for yourself. Ideally, tax planning should be carried out on a regularly basis, especially during the times when you receive your mid-year, year-end and/or performance bonuses to spread out the amount to be contributed so that it is not so onerous. In fact, for CPF cash-tops, you could even sign up for monthly contributions through GIRO.

Tax Optimisation for Your Family

Besides doing tax planning for yourself, you could also optimise the tax bill for your entire family. For example, the parent tax relief could only be claimed by 1 sibling for each parent. Ideally, this should be claimed by the person with the highest tax bracket as this will result in the largest reduction in the tax amount. There are also different amounts that could be claimed under the parent tax relief. For siblings who are staying with their parents, they can claim a higher tax relief of $7,000 compared to only $4,500 for those who are not. Hence, this can also influence who should be the one claiming the parent tax relief.

Likewise, for the Qualifying Child Relief, you could also decide with your spouse who should be the one claiming this relief so as to minimise the tax bill for the family.


Nobody likes to pay income tax. Tax planning will help to reduce the amount of tax you and your family need to pay. Tax planning is not necessarily for the rich, even middle-income families can benefit from it.

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Saturday, 7 December 2013

Doing Your Own Insurance Planning

I guess most people are familiar with the concept of insurance planning. Whenever you buy an insurance policy, the insurance agent will first carry out insurance planning to determine your needs. She will ask you some questions related to your monthly income, expenses, amount of assets, liabilities, etc. before proposing a suitable insurance policy. Since this is such an important step to determining your insurance needs, why not do your own insurance planning? 

Benefits of Insurance Planning

There are several benefits to doing your own insurance planning. Firstly, the results are likely to be more accurate. During the discussion with the insurance agent, unless you come prepared, you will be hard-pressed to estimate how much your expenses, assets and liabilities are. Some are also not comfortable disclosing the actual income or assets for whatever reasons. But in the comfort of your home and away from all the strangers, you have all the time to find out all these figures accurately. There is also the advantage of updating the insurance plan as regularly as you wish, without the need to seek another review session with the insurance agent.

The second benefit of insurance planning is knowing how your insurance needs vary with time and the age that you no longer need any insurance. This is important for those who prefer to buy term insurance and invest the rest of the money over life insurance. By knowing when the coverage is no longer needed, you can save more money for investment.

The third benefit is you can carry out sensitivity analysis to find out which parameter affects the insurance needs the most. For example, the disability income insurance that I have comes with an option for a 2.5% escalation in benefits every year. Is it better to increase the coverage by another $1,000 per month or opt for the 2.5% escalation? Sensitivity analysis tells me that it is better to increase the coverage than to have the escalation. Similarly, sensitivity analysis also tells me when can I retire given the expected income, expenses, assets and liabilities. Finally, sensitivity analysis tells me which of these parameters are my best friend and worst enemy.

Worst Enemy: Interest Rate

Here, interest rate refers to inflation. Inflation is the worst enemy because all expenses go up, thus increasing the insurance needs. Inflation on medical costs and education is likely to be higher than general inflation. Through insurance planning, I have realised that if a potential liability costs $10,000 today, we should really be covering for 3-4 times that amount (depending on the expected inflation rate), because if and when the liability were to happen in 20-30 years down the road, inflation is going to increase it by 3-4 times.

Best Friend: Interest Rate Too!

If inflation were the worst enemy, investment rate of return would be the best friend. If we could grow our wealth at a higher rate of return than inflation, then our wealth could keep pace with the expenses. The insurance needs will also be much more manageable. After all, when we pay insurance premiums to the insurance companies, they also invest the money to make sure that it grows sufficiently large to cover the sum assured when the liability happens. Insurance is not just about risk pooling but also about investment!

Notwithstanding the above, in my last blog post, I have highlighted that it might be difficult to invest at a high rate of returns when one is not in the best of health. This then becomes a double whammy, because one is unable to generate high returns while at the same time the insurance needs go up. Thus, health is all important and is the capital to generate wealth.


In conclusion, insurance planning is an important step in identifying one's insurance needs. It provides insights into how the insurance needs vary with time and the key parameters that significantly affect the coverage needed. Given its importance, why not do it yourself?

2 words of caution are needed, though. Firstly, the model to determine the insurance needs must be correct, otherwise, it will result in either under-coverage or over-coverage. Secondly, like all models, it is rubbish-in, rubbish-out. Not only the model must be correct, the inputs must also be accurate too! Nevertheless, given its importance, it is worth investing the time in building and fine-tuning the model and establishing accurate input parameters.

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Sunday, 1 December 2013

How Much Does One's Financial Independence Depend on One's Health?

It is an aspiration for most people to be financially free. Being financially free means being able to do what one likes without being tied down to a job that one doesn't like. This is usually achieved by having alternative sources of income that do not depend on one's job, such as dividends and rental income. However, how much does one's financial independence depends on one's health?

When one is healthy, one is able to analyse financial statements or read technical charts and make investment decisions. However, when one is unhealthy, all these take a back seat. As La Papillion pointed out in his comments to my previous blog post, financial issues are the last thing on one's mind; the first thing being spending more time with one's family and trying one's best to recover as fast as possible. Investment decisions that used to be made fairly quickly now get procrastinated. If timing plays a key role in the returns one gets, then the returns become diminished with procrastination. Financial statements that used to be read with care now becomes a chore and an obstacle to investment. Thus, is it truly financial independence when it depends on a healthy person to achieve it?

One may argue that regular dividends and rental income require minimal efforts to achieve. However, one still has to watch over the performance of the companies to make sure that the regular dividends can continue uninterrupted. History is full of examples of excellent, high dividend-paying companies that have failed. Rental income also requires one to look for new tenants when the lease expires and to carry out repairs to upkeep the property. So, efforts are required to maintain the regular income. Nevertheless, this post is not to belittle the financial independence that some have achieved. Being financially free is a great achievement that takes many years of hard work and financial prudence to achieve. Rather, this post is to allow one to ponder how much one's hard-won financial independence is dependent on one's health. If one's financial independence is not dependent on one's health, then that financial independence could also be transferred to one's loved ones so that they too could be financially free. 

I have not found an answer to how one can be truly financially free. But the closest thing to a company that can continue forever is an index, which renews itself based on economic trends and replaces outdated component stocks with new ones. And the closest thing to minimal maintenance of the investment portfolio is to create a regular savings plan which invests a fixed amount of money in the selected fund. The good thing about index investing is that it beats most of the actively managed funds.

Health is wealth. When one is healthy, one has the capital to be wealthy. But when one is not healthy, even wealth cannot buy health.

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Saturday, 23 November 2013

Preference for Regular Payout Insurance

I have a couple of insurance policies; these can roughly be grouped into 2 categories -- those that I didn't opt out and those that I voluntarily bought. Insurance policies that fall in the former group are CPF's Dependents' Protection Scheme and Home Protection Scheme (HPS) while insurance policies that fall in the latter group are the "as-charged" Medishield plan and disability income insurance. The key difference between the 2 groups is the former has lump-sum, one-time payouts while the latter have variable or regular payouts over a period of time. As shown in the title of this blog post, my preference is always for regular payouts over lump-sum payouts.

For insurance to be effective, the asset (from insurance payout) must match the liability. Not only must the value of the asset and liability match, the timing of these cashflows must match as well. An asset that is realised one year after the liability falls due is no help at all. The reverse is also true, as will be shown later, but it is always better to have the asset earlier than the liability. Thus, when buying insurance, one must estimate the nature of the liability and find the appropriate insurance to match both the value and timing of the liability. 

When an unfortunate incident happens, it is likely to have 2 components, an initial period when there is high cash outlay such as due to surgery, and an recuperation period when the cash outlay is lower than that during the initial period but is regular, such as due to follow-up consultations, medication or loss of employment. Depending on the nature of the incident, the initial period will dominate for some incidents (e.g. accidents) while the recuperation period will dominate for other incidents (e.g. disability). Insurance with lump-sum, one-time payouts will be useful for the first type while insurance with regular payouts will be useful for the second type.

It is not wise to use a lump-sum insurance to cover a liability with regular expenses, as there is no certainty that the one-time payout is sufficient to cover the regular expenses even if the value of the payout and expenses roughly match. Take for example, a one-time $100K insurance payout and a liability that requires $3K in expenses a month over 3 years. The payout only needs to be invested at a rate of 3.1% to support the required cash outflow. It looks simple enough and does not require a bull market to achieve this rate of return. However, how can one be certain that there will not be a bear market that ruins the investment? Hence, there are challenges in trying to convert a lump-sum payout to a regular payout. Moreover, considering that the person is no longer as healthy as before, would he still be able to invest as well as he is when he is healthy? Thus, it is best to leave the risk of investing to the insurer and look for a regular-payout insurance to cover such a liability.

Notwithstanding the above, it may be possible to modify the cashflow of the original liability such that the asset and liability now match. For example, a loan obligation may require regular monthly repayments. It is possible to make a lump-sum repayment to either extinguish or reduce the amount of monthly repayment required in the future. A lump-sum insurance will work well in such cases. CPF's HPS plan falls into this category by extinguishing the loan when an unfortunate incident happens. 

In conclusion, it is important to match the asset to the liability. Buying the right insurance matters.

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Saturday, 16 November 2013

Unforeseen Risk in My Medical Insurance

Insurance should always be the first "investment" in any investment plan, because any major medical expenses could easily wipe out years of hard-earned savings and investment gains. However, insurance is usually not discussed as much as investments because it is a boring and taboo subject. A common thinking among investors is to try to grow one's wealth through investment quickly enough so that one does not need insurance. However, how many of us could ensure that we could grow wealthy before we grow old? A well thought through insurance plan would go towards ensuring that we are well covered during the period when we're still growing our wealth and are most vulnerable to any major expenses. However, sometimes, even the best laid plans can go awry when one is not in the best of health.

I have a private "as-charged" Medishield plan (Plan B) that covers me for hospitalisation in a Class B ward. When I was healthier and bought the insurance, I thought I would stay in a Class B2 ward if I were to be hospitalised. I did not buy any rider to cover the deductible and co-insurance portions of the medical bill, as I believe that medical insurance should be to cover large medical expenses. Hence, the coverage of a Medishield Plan B was adequate -- stay in B2 ward, covered up till B1 ward. I could not imagine myself staying in a Class A or even a private hospital ward. The money saved from not staying in these more expensive wards could be spent on a nice little holiday later. In fact, I have occasionally thought about staying in a Class C ward to save more on the deductible and co-insurance portions.

Unfortunately, Man proposes, Heaven disposes. I have not been in the best of health in the last few years. This has exposed gaps in my thinking and a major risk in my medical insurance coverage. I have seen specialists as a subsidised patient in a public hospital, private patient in a public hospital and private patient in a private hospital. Needlessly to say, seeing the specialist as a subsidised patient is the cheapest, but it can take 1-2 months to make an appointment. Seeing as a private patient costs more than as a subsidised patient, but the cost differential between a public and private hospital is not major. The lead time for an appointment as a private patient in a public hospital can range from 1/2 week to 3 weeks, while a private patient in a private hospital can see the specialist on the same day. Hence, in my haste to seek medical attention, I have seen a private specialist in a private hospital on a few occasions. This then exposes me to the risk of being hospitalised in a private hospital ward. The Medishield Plan B that I have only covers 50% of the insurable expenses in a private hospital ward, which is as good as not having any insurance.

Is it a case of being penny-wise and pound-foolish in not buying the most expensive Medishield plan? I don't think so, because if that is the case, I would not have upgraded to an "as-charged" Medishield plan. It is a case of not being able to foresee how I would act when I am not well. 

What will I do now? One option is to upgrade to a Medishield Plan P that covers private hospital wards, provided I am still insurable. But frankly speaking, the annual premiums of Plan P are not cheap. If this option is chosen, at some point in time, I might downgrade to Plans A or B to manage the premiums. Anyway, there are going to be changes to the plans with the introduction of Medishield Life. I will wait and see the benefits and premiums of each Medishield plan before deciding.

If I am no longer insurable, I could only continue on Plan B, and if the specialist in the private hospital diagnoses that I need to be hospitalised, I would go to the Accident & Emergency Department of a public hospital to seek hospitalisation. That probably seems the best way to manage this risk. 

Sunday, 10 November 2013

Why Unit Trust Expense Ratio Matters

Many investors would have the familiar experience of finding it difficult to make money from unit trusts. My own experience with the few unit trusts that my family and myself bought is the same. In my last post, I charted the price performance of the 2 unit trusts in my Supplementary Retirement Scheme (SRS) account since my first investment 6 years ago. They have not recovered to the initial price which I made my entry even though the Dow Jones Industrial Average is reaching new highs. Why is it so difficult to make money from unit trusts?

There are several reasons for it. Firstly, studies have shown that it is very difficult for fund managers to beat the market indices. So, most actively managed funds actually fare poorer than the market indices. This poorer performance is even before deducting the sales charges and annual expenses of the funds. Secondly, the annual expenses of the funds is a huge drag on the fund performance. The typical equity fund charges approximately 2% of the fund's net asset value (NAV) annually. This goes towards paying the fund manager and trustee and for other expenses such as administration and audits.

At first glance, 2% of NAV might not seem a lot to pay for professional management of the funds. However, what is the annual returns that investors could realistically expect from equity investments? Approximately 10%. So, a 2% expense ratio out of 10% typical annual returns is equal to 20% of the annual profits that investors could expect. That is a lot of money! In poorer years, the equity returns would be lower than 10% or even become negative, but a 2% expense ratio is still charged. So, in poorer years, the fund managers get more than 20% of the profits that investors could earn in that year.

In comparison, hedge funds' fees comprises 2 components, namely, a management fee based on NAV of the fund (same as non hedge funds), at around 1-2% of NAV and a performance fee based on excess returns, at around 20% of returns above a pre-determined hurdle rate. Take for example, a hedge fund that has a fee structure of 1% of NAV and 20% of excess returns, hurdle rate of 2% and the underlying investments return 10% in a particular year. The total fee that the fund manager gets is 1% of NAV + 20% of (10% - 2%) or 2.6% of NAV in total. Although this is higher than the 2% expense ratio that non hedge fund managers charge, a majority of hedge funds have a high-water mark. If the returns of the hedge fund do not exceed the highest value achieved to-date, no performance fee is charged. So, for the same hedge fund, if the return of the underlying investments is 0% or negative in the subsequent year, the hedge fund manager will only receive the management fee of 1%. On the other hand, the non hedge fund manager will continue to receive the 2% expense ratio regardless of the performance of the underlying investments. From this perspective, the variable performance fee component of hedge funds is more palatable than the fixed management fee of both hedge and non hedge fund.

As a final note, the 2% expense ratio can make a huge difference in the total wealth after a long holding period due to the effects of compounding. Assuming the underlying investments earn 10% annually, a $1,000 investment in a typical fund with 2% expense ratio would become $10,063 while the same investment without the expense fee would become $17,449 in 30 years' time. The 2% difference in expense ratio causes a 73% difference in the total wealth.

Thus, do not underestimate the expense ratio of a fund. As far as possible, always select one with a low expense ratio. Index funds are a good choice, with low expense ratios and performance that are better than most actively managed funds.

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Sunday, 3 November 2013

Dollar Cost Averaging Works Best with Volatile Stocks/ Unit Trusts

I have 2 unit trusts in my Supplementary Retirement Scheme account. One is an equity unit trust (LionGlobal Infinity Global Stock Index Fund) while the other is a balanced unit trust (UOBAM Growth Path 2040). They are invested regularly on a monthly basis for the past 6 years. The relative performance of the 2 unit trusts since my first investment 6 years ago is shown in the chart below.

Relative Performance of Unit Trusts Since 1st Investment

From the chart, we can see that the performance of the balanced unit trust is more stable than that of the equity unit trust. During the Global Financial Crisis, it dropped to 60% of the initial investment price while the equity unit trust dropped even lower to around 45%. Subsequently, the balanced unit trust recovered to the 80% - 90% level and remained there for 3.5 years until February this year. In contrast, the equity unit trust recovered only to the 60% - 70% level during the same period and rising to the 80% - 90% level only recently. Throughout this period, the performance of the equity unit trust is worse that that of the balanced unit trust.

Yet, guess which of the unit trusts performed better in my portfolio? Surprising, it is the more volatile equity unit trust that performed better. It has returned 26% over the 6-year period compared to only 8% for the balanced unit trust.

The main reason for the better portfolio performance of the equity unit trust is because through regular monthly investment, the plan performs Dollar Cost Averaging (DCA). DCA buys more units when the price is lower and less when the price is higher. Since the equity unit trust has dropped more than the balanced unit trust, more units were accumulated. Hence, when the price recovers, the equity unit trust performs better, even though its price is consistently lower than that of the balanced unit trust throughout this period.

To conclude, Dollar Cost Averaging performs better with volatile stocks/ unit trusts than more stable ones.

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Sunday, 27 October 2013

The Best & Worst Months for Shares

In Jeremy Siegel's book "Stocks for the Long Run", it was mentioned that the best month for stocks is January while the worst month for stocks is September. October, although not the worst month, is the most volatile, having witnessed the stock market crashes of 1929, 1987 and more recently 2008. Let's review the case for Singapore to see if Singapore's stocks follow the same pattern.

The table below shows the average monthly return for the Straits Times Index based on data for the past 24 years since 1988 (2013 is excluded as there are still 2 more months to go).

Calendar Month Average Return Standard Deviation No. of
Best Months
No. of
Worst Months
No. of Best - Worst Months
Jan 0.8% 7.3% 5 2 3
Feb 0.9% 7.0% 2 1 1
Mar 0.5% 5.1% 0 1 -1
Apr 2.7% 6.5% 3 0 3
May -0.3% 7.6% 2 5 -3
Jun 0.2% 6.4% 2 1 1
Jul 1.6% 4.3% 3 1 2
Aug -2.9% 6.5% 0 5 -5
Sep -1.1% 7.1% 2 4 -2
Oct 1.0% 9.2% 1 4 -3
Nov 1.6% 5.6% 1 1 0
Dec 2.8% 4.9% 4 0 4

Based on the average monthly return, the best month is actually December at 2.8% while the worst month is August at -2.9%. However, if based on the no. of times that month has the best return in a calendar year, the best month is January with December not far behind. August remains the worst month. It is interesting to note that August was never the best month in any year. Similarly, December was never the worst month in any year. Based on the standard deviation of the monthly returns, October is the most volatile at 9.2% while July is the least volatile at 4.3%.

Hence, from the above analysis, Singapore stocks exhibit similar trends to US stocks, with December/ January being the best month while August/ September being the worst and October being the most volatile. The similarity in patterns should not be surprising, since stocks between US and Singapore are closely correlated.

From the last column of the table, it can also be seen that there is a sequence of positive returns from December to February. Similarly, there is a sequence of negative returns from August to October. Hence, there appears to be some sense in the adage "sell in May and go away".

Personally, do I follow calendar months when buying or selling shares? Actually not really. It is only a secondary consideration. The key consideration is still asset allocation and individual share performance. For example, if I intend to sell shares and January is around the corner with shares rising, I would wait till the end of January before selling. Sometimes, I might even wait till the end of February. Similarly, if I intend to buy shares and September/ October is around the corner and shares are falling, I would wait till the end of October before buying.

However, calendar effects do not always happen. Take this year for example. At end August, shares were falling due to widespread concerns that Fed might start to taper their Quantitative Easing (QE) programme. Shares dropped by 6.0% in that month. Given this backdrop, I would assume that the selling trend would continue into September and October. However, Fed did not taper QE against all expectations. Shares rose by 4.6% in September. Till yesterday, shares are up by 1.2% for October. So, calendar effects do not always happen.

In conclusion, there are certain months and quarters when shares are likely to perform better and certain months and quarters when shares are likely to perform worse. It is useful to know this information when buying or selling shares, but don't bet on it.

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Sunday, 20 October 2013

Do REITs Overpay for Their Acquisitions?

REITs have been active in acquiring properties to add to their portfolios. They do this to increase the rental income and distribution to shareholders as well as diversify the sources of rental income. In addition, there is also the potential for capital gains when the properties are sold. In the process of acquiring properties, they might also raise new capital from the market and increase the liquidity of the shares. However, do REITs overpay for their acquisitions in their attempts to expand? As industrial REITs are most active in acquisitions, we look at a list of acquisitions that industrial REITs have entered into with other companies.

Below is a table listing the acquisitions industrial REITs have carried out with other companies listed on the SGX, showing the acquisition price, valuation price and premium above the valuation price.

Property Date Price Buyer's Valuation Price - Valuation % Premium
65 Ubi Ave 1 May 2003 $35.0 $35.0 - -
1 Changi Business Park Ave 1 Sep 2003 $18.0 $18.0 - -
TT Int Tradepark Nov 2003 $92.0 $92.0 - -
12 Woodlands Loop May 2004 $24.8 $24.8 - -
9 Changi South St 3 Oct 2004 $32.0 $32.0 - -
5 Toh Guan Rd East Oct 2004 $36.4 $36.4 - -
52 Serangoon North Ave 4 Feb 2005 $14.0 $14.0 - -
84 Genting Lane Jul 2005 $10.0 $10.0 - -
20 Old Toh Tuck Rd Nov 2005 $11.6 $11.6 - -
50 Kallang Ave Dec 2005 $28.6 $28.6 - -
2 Serangoon North Ave 5 Dec 2005 $45.0 $45.2 -$0.2 0%
31 Ubi Rd 1 Dec 2005 $23.0 $23.0 - -
2 Senoko South Rd
26 Senoko Way
Oct 2006 $49.0 $49.0 - -
30 Woodlands Loop Nov 2006 $10.3 $10.4 -$0.1 -1%
20 Tampines St 92 Dec 2006 $10.0 $11.2 -$1.2 -11%
134 Joo Seng Rd Dec 2006 $10.7 $10.9 -$0.2 -2%
3 Changi South Lane Dec 2006 $13.9 $14.4 -$0.5 -3%
521 Bukit Batok St 23 Dec 2006 $24.1 $24.9 -$0.8 -3%
9 Tampines St 92 Dec 2006 $11.0 $11.0 - -
31/33 Pioneer Rd North
119 Neythal Rd
30 Tuas Ave 8
8 Tuas View Square
Aug 2007 $36.8 $37.6 -$0.8 -2%
31 Int Business Park May 2008 $246.8 $246.8 - -
1/2 Changi North St 2 Aug 2010 $22.1 $22.2 -$0.1 0%
25 Tai Seng Ave Sep 2010 $21.1 $21.5 -$0.4 -2%
4/6 Clementi Loop Mar 2011 $40.0 $40.0 - -
3C Toh Guan Rd East Nov 2011 $35.5 $35.5 - -
16 Tai Seng St Mar 2012 $59.3 $59.3 - -
15 Jurong Port Rd Dec 2012 $43.0 $43.0 - -
$37.2 $37.3

From the table above, we can see that most of the transactions are carried out at the valuation price. A minority of the transactions are at a slight discount, ranging from 1% to 11%. The average discount of all transactions is 1%. On this basis, REITs do not overpay for their acquisitions.

As the counter-parties to these transactions are also listed companies, the sellers might also announce the transactions on SGX. Some of the sellers would disclose their valuations of the properties, thus allowing us to see both sides of the transactions. The list of transactions with sellers' valuations is shown in the table below.

Property Date Price Seller's Valuation Price - Valuation % Premium
65 Ubi Ave 1 May 2003 $35.0 $35.0 - -
TT Int Tradepark Nov 2003 $92.0 $92.0 - -
20 Old Toh Tuck Rd Nov 2005 $11.6 $9.3 $2.3 25%
31 Ubi Rd 1 Dec 2005 $23.0 $23.0 - -
28 Senoko Dr Apr 2007 $12.0 $12.0 - -
31/33 Pioneer Rd North
119 Neythal Rd
30 Tuas Ave 8
8 Tuas View Square
Aug 2007 $36.8 $22.6 $14.2 63%
1 Kallang Way 2A Jan 2008 $14.0 $12.0 $2.0 17%
31 Int Business Park May 2008 $246.8 $246.5 $0.3 0%
29 Tai Seng Ave May 2010 $53.0 $40.0 $13.0 33%
1/2 Changi North St 2 Aug 2010 $22.1 $14.3 $7.8 55%
25 Tai Seng Ave Sep 2010 $21.1 $16.6 $4.5 27%
44 & 46 Changi South Rd Dec 2010 $16.8 $12.5 $4.3 34%
4/6 Clementi Loop Mar 2011 $40.0 $22.0 $18.0 82%
3C Toh Guan Rd East Nov 2011 $35.5 $31.0 $4.5 15%
16 Tai Seng St Mar 2012 $59.3 $59.0 $0.2 0%
15 Jurong Port Rd Dec 2012 $43.0 $33.0 $10.0 30%
$47.6 $42.6

From the table above, it is interesting to see that most of the transactions are carried out above the seller's valuation price, with premiums ranging from 0% to 82%. The average premium of all transactions is 24%. Note that these valuation prices are not historical costs at book value; they are obtained from recent valuations commissioned by the sellers.

So, we are back to the original question: do REITs overpay for their acquisitions? To answer this question, we need to address 2 other questions, i.e. why do buyer's and seller's valuations differ, and the relative bargaining powers of buyers and sellers.

It is not uncommon for valuations of the same property to differ. Based on the disclosure in the SGX announcements by both buyers and sellers, 2 key reasons could be distilled:
  • Buyer's valuations are more rigorous than seller's valuations. Buyer's valuations are generally based on 3 or more valuation approaches, some of which include direct comparison of recent transactions, discounted cashflow of income stream, capitalisation of income stream and replacement cost of the property. In contrast, seller's valuations (note: there are only 5 sellers that disclosed the valuation approaches used) are based on less approaches, including desktop valuation. Furthermore, some of the acquisitions need to be funded by bank loans. If the properties are overvalued, banks would run the risk of loss. On this basis, the "correct" value of the property probably lies closer to the buyer's valuation.
  • Basis used in valuations. The basis used in valuations play a key role in the eventual value of the property. In one of the sellers' announcements, it mentioned about valuations on a sale-and-leaseback basis and on a vacant possession basis. Needless to say, the valuation on a sale-and-leaseback basis should be higher than on a vacant possession basis given that the leaseback agreement provides a rental guarantee for several years.

On the relative bargaining powers of buyers and sellers, even though the seller might have a valuation price, it does not necessarily mean that the seller would be willing to sell at that price. The seller probably had been operating from the property for several years already and enjoying continual appreciation in property values. Some premium above the seller's valuation price is required to entice the seller to sell the property and give up future capital gains as well as converting from being a property owner to a property lessee.

Lastly, of all the properties mentioned above with the latest valuation, only 2 properties have seen their valuations fall below the original purchase price.

In conclusion, on the basis that (1) the acquisition price does not differ much from the buyer's valuation price, (2) the "correct" value of the property probably lies closer to the buyer's valuation than the seller's valuation, (3) a premium is likely required to entice the seller to sell the property, and (4) the current valuation of most properties mentioned above is equal to or above the original purchase price, REITs do not overpay for their acquisitions.

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Sunday, 13 October 2013

Managing Expenditure

Saving is usually the first step towards achieving your financial objectives. One approach of building up savings is to have additional sources of income. The other approach is to defer consumption to a later date. To manage my expenditure, I have tried several ways over the last 2 decades; some work and some don't quite work. Let's discuss the ways that don't quite work before discussing the ways that work.

Ways That Don't Quite Work

The conventional way to manage expenditure is to set a budget for the various categories of expenditure. After trying for several years, I have come to the conclusion that budgets don't work. It works well for expenditure that are regular, such as utilities, taxes, etc. But when it comes to discretionary expenditure such as recreation, social events, etc., the budget is sometimes exceeded. The main reason is that the budget does not come to mind at the time of spending money. By the time I remember about the budget, money is already spent.

Related to setting a budget is to record all the expenses made. By recording and compiling all the expenses, you can analyse at the end of the day/ week/ month whether the money has been spent wisely and if not, to remind yourself to spend wisely the next time. Again, it does not quite work. Regret only lasts for as long as I'm looking at the expenses. It does not last until the time of spending money.

Perhaps the only time that budget setting and expense recording work is near the end of the month. If the budget is almost exceeded, I would try to defer some expenses to the next month.Conversely, if I spend less in this month, I would bring forward some expenses from the next month so that more money is available for spending next month. This is usually done by topping some stored value cards that are regularly used.

Ways That Work

The ways that work in managing expenditure (at least for me) has to do with how we think about expenditure. There are 2 ways of thinking about expenditure. The first way is to think of it in terms of opportunity cost. When you spend money on certain items, it means that you can't spend on some other items. As investors, it also means that the money cannot be invested and grown. Hence, the opportunity cost to investors is usually very high. The higher the rate of return and the younger the investor is, the higher is the opportunity cost. As an illustration, I have a target rate of return of 10% per year. At this rate of return, money will double every 7.2 years. I have 27 years before reaching the retirement age of 65. So, every $1 today will become $14.81, say, $15, when I retire. That means that for every $1 I spend today, I will have $15 less when I retire. Hence, the price tag of every item today is multiplied by 15. A mid-level digital camera that costs $2,000 to most people will actually cost $30,000 to me. That is a lot of money! From this perspective, I would think very hard about spending money on big-ticket items.

The second way of thinking about expenditure is to think about the amount of hours you need to put in at work to pay for the item. Let's say the expenditure is equivalent to 2 weeks of salary. Instead of the company paying you a monthly salary and using part of the salary to pay for the item, would you be willing to work for FREE for 2 weeks and at the end of the 2 weeks, the company gives you the item? Bear in mind that during these 2 weeks, you will need to endure the usual scolding from the bosses, tight deadlines, office politics, etc. Very likely, you will think a little longer about spending the money.


Generally, my experience is that if you manage the big-ticket expenditures well, you do not really need to worry too much about the small-ticket expenditures. You might overspend on the small-ticket items, but they will not blow a big hole in your pocket. Managing expenditure is not about being a miser; it is about knowing when to spend.

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Sunday, 6 October 2013

Clean Out CPF Balance When Taking HDB Housing Loan?

When you take a housing loan from HDB, it will take all the money in your CPF Ordinary Account (OA) before giving you the loan. This is to reduce the loan quantum that you need to service. To avoid having an empty OA account, you'll need to transfer some or all of the OA balance to somewhere else before you apply for the loan. One way is to invest in some bond or money-market unit trusts that will not drop too much in value while you're holding them. But the key question is, do you want to leave some money in your OA account or clean it out? It depends on whether you have any need for the OA money in the future and your risk preference.

There actually isn't a lot of approved uses for the OA money. Besides building up your retirement nest egg, you can buy properties, service insurance policies, invest in stocks and unit trusts and finance your family members' tertiary education. If you foresee that you need to use the OA money for such needs in the short- and long-term, then it's better to keep some money in the OA. This is because if you have an empty OA account, it'll take a fairly long period of time to build it up again as the monthly loan repayment will take a portion of your monthly CPF contributions. In any case, assuming you keep some money in the OA but later find that you have no other need for it, you can always make a lump sum repayment to reduce the loan quantum.

The second factor that you need to consider is your risk preference. Do you prefer a bigger debt burden (and bigger OA balance) or a near-empty OA balance (but smaller debt burden)? Some people will prefer to have a smaller debt burden so as to reduce the amount of interest payable over the loan tenure and/or to become debt-free earlier. Personally, I prefer to have a bigger OA balance. The main reason is it takes a long time to build up the OA balance when you start to service the loan as explained earlier. If, for some reasons, you are in between jobs for several months, the OA balance will quickly become insufficient to service the monthly repayment and you might risk losing your flat (I understand HDB is quite forgiving if you miss a few monthly payments, but the risk exists). Not only that, you might also default on other financial commitments such as insurance premiums, risking your insurance coverage as well. For this reason, I prefer to live with a bigger debt burden than to risk a snowball default. Of course, you can always make up any shortfall with cash, but it would be a constant worry over the low OA balance.

It also helps that the HDB loan interest is only 0.1% higher than the OA interest rate. At 0.1%, you pay an extra $100 for every $100,000 in your OA balance that is not being used to repay the loan. Over a 25-year loan tenure, this works out to be $3,112. This extra payment is like insurance premium, to guard against a snowball default and constant worry over the low OA balance. Not only that, you get to save the money for some other uses in the future and have the flexibility of making a lump sum repayment. And if you manage to invest the OA money at a rate higher than the loan interest, you get to grow a bigger retirement nest egg as well!

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Sunday, 29 September 2013

Housing Loan Servicing – Cash or CPF?

Should you use cash or CPF to service your housing loan? Most people would use CPF, so as to conserve the cash for other purposes. Moreover, CPF money is considered as being "locked up", so you cannot use it for most other purposes. However, if you have the cash, does it make financial sense to service the housing loan using cash?

The main argument for using cash to service the housing loan is because interest rates for cash savings are so low, at around 0.05%, whereas the interest rate for CPF Ordinary Account (OA) is at 2.5%. By using cash to service the loan and keeping CPF untouched, effectively, you gain 2.45% on the loan repayment annually. Considering the effect of compounding over time, this can add up to quite a bit of money over the length of the loan tenure.

Besides these 2 options, there is a middle option, which is to service the loan using CPF and top-up the CPF using cash. Effectively, you are servicing the loan using both cash and CPF. (Note: the cash top-up into CPF goes into the Special Account (SA). When the upper limit for SA is reached, the balance will overflow into OA that is used to service the loan. But when the limit is reached, it also means that no further top-ups are allowed under the Minimum Sum Scheme). When you top-up CPF using cash, you can also claim for tax deduction for up to $7,000. If your marginal tax bracket is 7%, that means a tax savings of $490 annually. That can also add up to quite a bit of money over time. So, the question is which option makes the most financial sense -- servicing the loan using cash, CPF or CPF top-up?

To answer this question, let's consider the following scenario:

Loan Details
Loan Principal  $200,000
Loan Tenure 25 years
Loan Interest Rate 2.60%
Annual Loan Repayment  $  10,980

Income Details
Annual Income  $  60,000
CPF  $  12,000
Annual Taxable Income  $  48,000
Annual Income Tax  $    1,110
Cash  $  46,890
CPF Top-up  $    7,000
Cash Interest Rate 0.05%
CPF Interest Rate 2.50%

Let's further assume that all the cash earned is not spent but saved in the bank. At the end of the 25-year loan tenure, the total amount of cash + CPF for the 3 options are as follows: 

Using Cash Using CPF CPF Top-Up
Year Cash Bal CPF Bal Cash Bal CPF Bal Cash Bal CPF Bal
0  $             -    $             -    $             -    $             -    $             -    $             -  
1  $      35,910  $      12,000  $      46,890  $        1,020  $      40,380  $        8,020
2  $      71,838  $      24,300  $      93,803  $        2,066  $      80,780  $      16,241
3  $     107,785  $      36,908  $     140,740  $        3,138  $     121,201  $      24,667
4  $     143,749  $      49,830  $     187,701  $        4,237  $     161,641  $      33,304
5  $     179,731  $      63,076  $     234,685  $        5,363  $     202,102  $      42,157
6  $     215,731  $      76,653  $     281,692  $        6,517  $     242,583  $      51,231
7  $     251,749  $      90,569  $     328,723  $        7,700  $     283,084  $      60,532
8  $     287,785  $     104,833  $     375,777  $        8,913  $     323,606  $      70,066
9  $     323,840  $     119,454  $     422,855  $      10,156  $     364,148  $      79,838
10  $     359,912  $     134,441  $     469,956  $      11,430  $     404,710  $      89,854
11  $     396,002  $     149,802  $     517,081  $      12,736  $     445,292  $     100,121
12  $     432,110  $     165,547  $     564,230  $      14,075  $     485,895  $     110,644
13  $     468,237  $     181,685  $     611,402  $      15,447  $     526,518  $     121,430
14  $     504,381  $     198,227  $     658,598  $      16,854  $     567,161  $     132,486
15  $     540,543  $     215,183  $     705,817  $      18,295  $     607,825  $     143,819
16  $     576,724  $     232,563  $     753,060  $      19,773  $     648,508  $     155,435
17  $     612,923  $     250,377  $     800,327  $      21,288  $     689,213  $     167,341
18  $     649,139  $     268,636  $     847,617  $      22,840  $     729,937  $     179,545
19  $     685,374  $     287,352  $     894,930  $      24,431  $     770,682  $     192,053
20  $     721,627  $     306,536  $     942,268  $      26,062  $     811,448  $     204,875
21  $     757,898  $     326,199  $     989,629  $      27,734  $     852,233  $     218,017
22  $     794,187  $     346,354  $  1,037,014  $      29,448  $     893,039  $     231,488
23  $     830,495  $     367,013  $  1,084,422  $      31,204  $     933,866  $     245,295
24  $     866,820  $     388,188  $  1,131,855  $      33,005  $     974,713  $     259,448
25  $     903,164  $     409,893  $  1,179,311  $      34,850  $  1,015,580  $     273,954
Cash + CPF $1,313,057 $1,214,161 $1,289,535

As shown in the scenario above, using cash to service the loan is still the best option. Using only CPF to service the loan is always the worst option because of the higher CPF interest rate. Although the CPF top-up option generates tax savings, the amount of tax savings is insufficient to compensate for the loss in interest for keeping as much money in the CPF as possible.

There could be other scenarios in which the CPF top-up option might be better than the cash option. Some of the factors that could affect the outcome are as follows:
  • Cash interest rate versus CPF interest rate. By design, the CPF interest rate will always be higher than the cash interest rate. The higher the CPF interest rate relative to the cash interest rate, the more beneficial it is to keep as much money in the CPF as possible. But when the cash and CPF interest rates are close to each other, the tax savings from CPF top-ups will make this the best option.
  • Amount of CPF top-up versus CPF draw-down for loan repayment. In the scenario above, the amount of CPF top-up is $7,000 while the amount of CPF draw-down to service the loan is about $11,000. Hence, $7,000 of the loan repayment is serviced by the cash top-up into CPF while $4,000 is serviced by money originally in the CPF. Over the loan tenure of 25 years, the tax savings from CPF top-ups is insufficient to compensate for the loss in net interest from a smaller CPF balance. If the amount of CPF top-up and draw-down is close to each other, the tax savings from CPF top-ups will make this option the best one.
  • Loan tenure. As explained above, the longer the loan tenure, the larger is the compounding effect of the higher CPF interest rate.
  • Marginal tax bracket. In theory, the higher the marginal tax bracket, the greater the amount of tax savings from CPF top-ups. However, you will need a really high income for the tax savings to outweigh the loss in net interest and the effects of compounding.

In conclusion, based on the current interest rates and policies, using cash to service the housing loan usually makes the most financial sense. Nevertheless, servicing the loan using CPF and topping-up the CPF using cash provides greater flexibility in the future when interest rates and policies might change.

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