The introduction to Asset Allocation (Part 1 of 2)

The initial posts and first few are going to be basis of my investment blog journey. Like all other things we do in life, we build a strong foundation so knowledge are going to be the foundation of all things. Foundation are extremely boring stuffs but that is what keeps us going for a long long time. In this post, I'm going to discuss about introduction of asset allocation but before that, asset allocation is not really for everyone but it does help in the long run. Eventually, where you would want to put that extra cash into is something that you want to choose from the many options available.

Now, many, most, probably 70% of us are either retail investors or you can say mass affluent and majority of us on this island probably are beginning on our journey to financial freedom. What is financial freedom actually? It just means free yourself from slavery of money. When you know that you no longer require that monthly income you are getting from somewhere and you have no liabilities, I think you can safely say you are out  of the rat race.



Networth = Assets + Liabilities

Simple Mathematics really:

IDEALLY:

Liabilities = $0
Assets = Cash, investments, gold, mint toy set, jewelry, something that is of value

Networth = Assets (This means positive cash-flow)

ACTUALLY:

Liabiltiies = Mortgage Loans, Personal Loans, Car loans, Loans from family/friends, Credit card
Assets = Cash, investments, gold, mint toy set, jewelry, something that is of value

Networth = Assets - Liabilities (Most people are in negative cash-flow)



Unfortunately and fortunately, most of us fall into the second category. Well, I can't say that it's a bad thing because a fraction of your assets in loans will be quite the healthy thing to do. Over-leveraging is also something not that everyone can do as well. Interesting rates are rising slowing while deposits and yields and decreasing, the margin where you may take a loan to get potentially higher returns will be reduced.

What is asset allocation? In simple layman terms it just means buying and keeping a little bit of everything that you can financially classify into. Buy a DBS stock and a UOB stock does not qualify as a different asset class but separating out your funds into DBS stock and a UOB bond would be the case. The main allocations are known as:

1. Cash
2. Fixed Income/Bonds/Debts
3. Equity/ETFs
4. Alternative Investments
5. Private Equity

What are our locals favorite asset classes to date when we invest? Make a quick guess, that's equity and most of the time pure Singapore equities (Catalist and Main Board listing) and the majority would go into……….Cash! Yes, Cash. Singaporeans favorite hobby is to scout for the highest interest rate/best deal in town and place most of their cash into a fixed deposit and in recent years some slight re-engineering of the fixed deposit came in the form of a bonus account (Credit card with minimum monthly spending, New funds and Salary crediting) I must say, that was indeed something refreshing and from the looks of how OCBC 360 started this and how eager DBS, UOB, POSB and Bank of China followed suit do mean that this actually gets attention to get potentially higher interest from cash holdings.

This is a huge topic and would cover in two simple parts (Cash, Fixed Income and Equity for Part 1 and Alternative investments and Private Equity for Part 2)

I'm going to skip to point three for now as I hear many people say and tell me, especially during their experiences with the stock market when they started investing. Some say short term gains, some say long term holdings. Those who told me they wanted short term gains ended up trading on the Catalist (Penny Stock) and eventually became long term investors and probably holding on till now since we "HOPE" it may always go back or higher. Now those who wanted to keep deep value companies ended up trading the stock for short term gains once the call was right, thinking about having both trading conditions once they get the confidence and boost from making the right decision. Sometimes I even hear some investors saying they can't lose while some just look to blame someone when they lose. Well, I can only say that if you can't accept losses then probably you shouldn't even start in the first place.

Equities are one of the most volatile asset classes in our portfolios. They determine the performance of the portfolios and in good years, easily double digits and in bad years, double digits as well on the other end. Equities move fast as it is a representation of investor's view of the company's situation. In Singapore's SGX context, the market is relatively small and well we were much smaller in the 1990s and it is really kind of difficult to be more exciting while facing HongKong as a financial hub. Now, equities are actually very exciting for investors and also for myself. Buying a small stake into a company literally means that you are a shareholder in the company and you take on the common share (Meaning if the stock goes to $0, the value of your holdings goes to $0)

Equity ETFs (Exchange Traded Funds) are slowly coming into our local play as part of different types of investments. These investments just means that they are made of specific weightage on a basket of equities in certain sectors. They are more passively traded and tries to follow a certain index and the constituents. I.e. some people say that these are low costs and diversified equity sectors. I wouldn't really call it diversified sectors actually because if you look into HK Index ETFs, they are predominantly made up of financial sector so that wouldn't really be diversified isn't it? Of course the nature of the country's index is very dependent on the financial sector in this situation.

The last segment for Part 1 will be debts and it is most referred to as fixed income. Why Debt and Fixed Income? Really confusing though on the terms - Debt just means another syndication of fund raising. Companies does fund raising all the time through the old channels. In the stock market, they raise funds through making available certain portion of the company holdings for private and corporate investors and similarly in the debt market, companies raise funds through wealthier investors and corporates and in return, the companies pays you a fixed form of returns during certain periods (Mostly semi annual or annually) Most of the time the minimum sum for such debt investment can be up to SGD 250K or USD 200K with some exception of USD 2K. Fixed Income assets do come in higher in rank as compared to an Equity counter. In layman terms, if the company files for bankruptcy the liquidation of the assets goes towards debt repayment first and if there are any excess, it will channel back to common shareholders. Interestingly, Fundsupermart has worked with regulators and do have retail tranches of fixed income investment available to retail investors but only in SGD denominated bonds.

I'm not going to confuse things further but there are such things as bond ETFs that is basically more cost effective and a lower barrier to entry but these are denominated in USD. There are new tools to investments and readily available to retail investors known as crowd funding and these are debts as well with high-yield income and more complications which I would take some time in the future to discuss about.

Generally Rule of Thumb on Fixed Income Assets: Interest rates are inversely proportional to Bond Prices. (In simple terms, If the USA Central Bank officially hike the interest rates, Bond prices will come down and vice-versa)



Asset Classes are an important part in building a portfolio but not that easy to grasp. As usual, Keep things Simple and Sweet. More to come and we could run off faster as the days goes by.