Basics of Investment

1. Basics of Investment 2005

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

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

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

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

6. Answer : • Depends on your • Goals • Age • Asset Size and • Risk Tolerance ….

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

8. Setting up Investment Policy • Return Objective (Goals) • Risk Tolerance • Subject to ; • Time Horizon • Liquidity Requirement • Laws & Regulations • Taxes where applicable • Unique Needs

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

10. Data From 1926-2001

11. Return in US Stock Market Eg. US Stock market investment of US$100 in Dec 1981 S&P 500

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

13. S&P Monthly Returns Monthly Returns of US Stocks have been Volatile

14. Source : Stocks, Bonds, Bills and Inflation 2002 Yearbook

15. Setting up Investment Policy • Return Objective (Goals) • Risk Tolerance • Subject to ; • Time Horizon • Liquidity Requirement • Laws & Regulations • Taxes where applicable • Unique Needs

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

17. Investing in Shares of Companies • 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) • These risks need return compensation. Sometimes you are well compensated, other times you are not. • Solution : DIVERSIFY, across many stocks, many sectors, many markets. • Simpler solution : BUYING INDEX FUND

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

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

20. Setting up Investment Policy • Return Objective (Goals) • Risk Tolerance • Subject to ; • Time Horizon • Liquidity Requirement • Laws & Regulations • Taxes where applicable • Unique Needs

21. a. Time Horizon • 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.

22. Phases of Life

23. Setting up Investment Policy • Return Objective (Goals) • Risk Tolerance • Subject to ; • Time Horizon • Liquidity Requirement • Laws & Regulations • Taxes where applicable • Unique Needs

24. b. Liquidity Requirement • 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

25. Setting up Investment Policy • Return Objective (Goals) • Risk Tolerance • Subject to ; • Time Horizon • Liquidity Requirement • Laws & Regulations • Taxes where applicable • Unique Needs

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

27. More Diversification • Spreading your risk • by investing in a variety of assets to protect your overall investment without sacrificing too much of expected return. • 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.

28. Various Asset Classes and the Risk Profile

29. Currency Risks • 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 • Currency Management may prove important in a diversified portfolio. More importantly are the goals of the fund

30. S&P 500 index US$ vs SGD$ • 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.

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

32. Investment Policy Example : Mr Ash Burn • 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 • 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 ; • Time Horizon - 31 years to go before 1st Payment • Liquidity Requirement - No real need of liquidity from this investment fund • Laws & Regulations - US law & regulation applies • Taxes where applicable - No tax concessions

33. Investment Strategy Example : Mr Ash Burn Based on the policy set in the previous slide example recommendation for Mr Ash Burn is as follows;

34. Investment Requirement 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)

35. Investment Requirement • 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 1st year, $427 in the 2nd 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

36. Policy Review – Mr Ash burn • 1 year later, the investment policy is reviewed • 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 • All of which will require a different investment strategy and hence different monthly installments

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

38. 4 Key Points • Set up Investment Policy - Return & Risk goes hand in hand • Avoid “get-rich-quick-and-no-risk” schemes • Regular Review of Investment Policy • At least once a year • Adjust Risk Lower Towards Maturity • Regular Investments • Avoid the need to time market • Entry points are averaged over the long run • Painful lump sum investment can be avoided • Diversified Portfolio • Fund Type Investments generally simpler • Avoid the pain of being hit by specific risks

39. Appendix

40. More Classes of Assets Trade-offs between Return and Risk High Return normally associated with High Volatility

41. Risk versus Return Yet another chart depicting various assets’ return and risk characteristics (from the point of view of US investors)