What Novice Investors Should Go For: ETFs

Foreword from ShareInvestor

This article “What Novice Investors Should Go For: ETFs” by Goh Eng Yeow was first published in The Straits Times on 09 Mar 2014 and is reproduced in this blog in its entirety.

Exchange-traded funds offer simple way to gain exposure to pricey blue chips

During a recent meet-the-author session organised by Books Kinokuniya, some novice investors asked me how they could invest successfully in the stock market even though they were not financial experts.

One was a single mother who had just bought an HDB flat and said she had never made a cent on her stock investments. Another was a young man clutching a copy of my book, Small Change: Investment Made Simple, as he queued to get my autograph.

I can understand their predicament. Most investors commencing their life journey would face the same doubts.

And since such investors have worked for only a few years, the stock market is one of the few options where they can hope to grow their wealth with their slender cash resources. Other choices such as buying a flat for investment would be out of the question, given the big initial cash outlay involved.

But there is one advantage I enjoyed over the current generation of new investors. When I embarked on the same journey almost 30 years ago, I had fewer distractions.

Unlike an investor who can get a minute-by-minute update on the valuation of his stock portfolio just by tapping on his smartphone, I had to call up a broker to get a stock price or wait for the following day’s newspaper.

So even when a major incident hit, such as the Pan-Electric crisis in 1985 which led to the collapse of five broking firms and a three-day closure of the stock market, it hardly caused a flutter among small retail investors like myself.

But things have changed a lot since the 1980s. A similar calamity on the scale of Pan-Electric would be catastrophic for small investors now.

Today, the average investor is bombarded daily by the chatter on the airwaves from television stations such as CNBC and the Internet about the market, the economy, interest rates, price targets for stocks and so on.

And as the barrage of information hits them, they are constantly urged to do something by commentators, whether it is to buy or sell a stock, when they may be better off doing nothing at all.

So I don’t blame the novice investor for becoming confused by the conflicting signals he gets and becoming disillusioned with the stock market as he encounters losses on his investments.

However, there is one financial innovation in the past decade worth highlighting. This is the exchange- traded fund (ETF), which is the one asset a new investor should consider putting his money into.

An ETF – as its name implies – is a fund traded on the stock exchange which pools money from investors to buy into baskets of stocks tracking widely watched market indexes such as the Straits Times Index (STI).

With an ETF tracking the STI, an investor can get exposure to pricey blue chips such as DBS Group Holdings, OCBC Bank and SingTel at a fraction of the costs he might have to pay if he tried to buy these stocks himself.

And this is the big selling point of the STI ETF: If you believe that Singapore will do as well in the next 30 years as it has done in the past 30, this is one investment to hold, since it has almost every Singapore household business name in it.

But the pity is that even though the STI ETF has been traded on the Singapore Exchange for a few years now, many investors are still unaware of it. This point was brought home to me at a recent gathering where I was seated next to a food writer who said she had not heard of the STI ETF, even though she read the Money pages of The Straits Times every day.

The other problem which a new investor has to overcome is to get the timing right on when to enter the market. Buy at a time of extreme exuberance and, sure as night follows day, he will suffer a big loss when share prices drop.

Legendary investment guru Warren Buffett’s antidote to this problem is to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs.

He said: “Follow these rules, the know-nothing investor who both diversifies and keeps his trading costs minimal is virtually certain to get satisfactory results.”

Indeed, this is the instruction which Mr Buffett has left trustees on his bequest to his wife: Put 10 per cent of the cash in short-term government bonds and 90 per cent in a low-cost S&P 500 Index fund.

He said: “I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers.”

For the novice investor, the local equivalent to an S&P 500 Index Fund would be the STI ETF. He can start by opening a savings account with POSB or OCBC Bank, which can buy the ETF on his behalf for as little as $100 a month.

That, in a nutshell, was the advice I gave to novice investors at my meet-the-author session on how to invest successfully for the long term while minimising the risks.