Which investment portfolio type should you adopt?
Disclaimer: Please note that all content and information in this blog are for educational and informational purposes only and should not be taken as professional investment advice.
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As a general framework, there are three types of portfolios which investors can consider: passive, moderate and aggressive, constituting of 55%, 70% and 90% in equities respectively. The three sample portfolios below exclude one's emergency savings as well as CPF, as emergency savings and CPF are designed to meet both our short-term needs (such as monthly expenses), and long-term needs (for retirement) respectively. Thus, the funds in our emergency savings and CPF are money that we cannot afford to lose. As such, I would view them separate from any investment portfolio. The non-equities component constitutes Cash, T-bills and Bonds respectively to meet our short, medium and long-term liquidity needs respectively. The equities component constitutes of MSCI World Index, the three major US Indexes, SG Banks and SG REITs.
15% Cash
15% T-bills
15% Bonds
15% MSCI World Index
5% S&P 500
5% Nasdaq 100
5% Dow Jones
15% SG banks
10% SG REITs
Moderate (70% Equities)
10% Cash
10% T-bills
10% Bonds
20% MSCI World Index
10% S&P 500
5% Nasdaq 100
5% Dow Jones
20% SG banks
10% SG REITs
Aggressive (90% Equities)
5% Cash
5% T-bills
25% MSCI World Index
10% S&P 500
10% Nasdaq 100
10% Dow Jones
25% SG banks
10% SG REITs
Rationale behind each component
1. Cash, T-bills and Bonds
2. MSCI World Index
3. S&P 500, Nasdaq 100 and Dow Jones
4. SG Banks
5. SG REITs
1. Cash, T-bills and Bonds
These three components make up the non-equity portion of the portfolio. Liquid cash holdings are split into Cash and T-bills equally to meet our short and medium-term liquidity needs. With T-bills being either 6-months or 12-months, they are definitely less liquid than cash. However, having a maturity of less than a year, it is still an ideal place to park cash for your medium-term needs (e.g., warchest).
Creating a T-bill ladder to ensure a constant cash flow each month would be ideal. This ensures that you will always have sufficient warchest cash available on hand to invest should the market enter a correction or bear market.
Cash on the other hand, being more liquid, is an ideal place to park funds to meet our short-term liquidity needs. Funds here are primarily to ensure you have cash available on hand any day to invest should there be a sudden buying opportunity. Also, having sufficient cash on hand is needed for dollar cost averaging (DCA), whether on a weekly, fortnightly or monthly basis, since we can only DCA with the liquid cash on hand, meaning we cannot park such under T-bills.
Some suitable high interest savings accounts which provide liquidity include UOB One (4% p.a.), Standard Chartered e$aver (3.45% p.a.), Maribank (2.88% p.a.) and GXS Bank (2.68% p.a.), with all having no hoops to jump through except for UOB One requiring salary crediting and >$500 monthly credit card spending and a $150k deposit to maximise the 4% interest. Standard Chartered e$aver interest only applies to incremental balances which makes it ideal to switch in and out every 2 months (as the high interest applies to incremental balances for 2 months, with respect to the previous month's monthly average balance).
Alternatively if we have no other high interest savings account option available, SSB provides an additional option, albeit at a cap of $200k and less liquidity compared to high interest savings accounts (since the funds will only be received the following month upon redemption). If a given a choice, one should still park the bulk of their short-term cash in high interest savings accounts, while SSB can be used to complement one's CPF, meaning that SSB is excluded from our investment portfolio completely.
Ultimately whether to include SSB in our investment portfolio depends on our personal circumstances and preferences. Personally, I view SSB as a complement to my CPF for growing our retirement nest egg risk-free and in the most hassle-free way, while reserving high interest savings accounts to park cash for short-term liquidity needs.
Lastly, bonds would be where we park our long-term cash reserves. While some people would view their CPF as a bond component of their portfolio, as mentioned, CPF is meant to provide for our basic retirement needs and should not be confused with our investment portfolio, which is primarily meant to provide beyond our basic retirement needs (e.g., as an extra source of passive income or for bequest). While CPF would be a good bond component of any investment portfolio, it's primary purpose is for retirement and hence one should have a separate bond component in their investment portfolio to balance the equities component, and not use the CPF as a bond component or safety net to back-up our more risky investments like those in equity. Our investment portfolio should have its own separate bond component that is independent from our CPF, allowing us to tide through the market ups and downs in the long-term with greater peace of mind. Ultimately it depends on one's individual views but to mitigate the risk in our investment portfolio it would be wise to build up a strong non-equities component constituting of Cash, T-bills and Bonds to counteract the volatility of our portfolio's equities component.
For the bonds component, while SSB is a good option, SGS, bonds, corporate bonds (minimally AA-) (usually requires >$200k min investment), Temasek Bonds, Astrea Bonds, etc offer a greater variety. As mentioned, I personally believe SSB help complement our CPF and thus should be excluded from our investment portfolio entirely. However, if you have limited capital or options available, then SSB can be used as a bond component in your investment portfolio.
To sum up, SSB are flexible in terms of its use in complementing our CPF or forming part of our investment portfolio (whether as a Cash or Bond component). However, personally, I would separate it from our investment portfolio and use it to complement my CPF. As CPF is by nature not liquid, SSB can complement it by being the liquid part of our CPF, making it ideal for those who plan to retire early (i.e., F.I.R.E.) and are unable to draw their CPF OA before turning 55 years old.
2. MSCI World Index
This forms the largest part of the equities component of the portfolio because it theoretically has the lowest risk. Being an ETF measuring the global market, it completely removes all idiosyncratic risk, which is present in all stocks and non-global ETFs, including the three major US Indexes.
As the MSCI World Index diversifies across most countries and all industries, it is one of the safest options for long-term investors who do not wish to activately monitor their investments. Unlike the three major US Indexes, the MSCI World Index does not depend on the US economy or the economy of any country because it takes the collective performance of most countries' economies (i.e., the global economy).
While the MSCI World Index compromises mainly of US companies (around 70%), this weightage would change over time, especially if the US economy underperforms compared to other countries. As an index, the MSCI World Index rebalances regularly, meaning it would naturally select the top performers and biggest players in the global economy to take up the largest weightage of the index. Similar to most indexes, this would naturally reduce and eliminate underperforming companies from the index, except that in the case of MSCI World Index, this applies not only to companies but to countries as well since the index is diversified globally. Thus, for most investors, the MSCI World Index should form the largest proportion of the equities component of your portfolio.
Being a global index, investors could even allocate 100% of their equities to it since it is already so well-diversified with zero idiosyncratic risk unlike individual stocks or even other non-global indexes.
3. S&P 500, Nasdaq 100 and Dow Jones
The rationale behind including the three major US Indexes despite already including the MSCI World Index is that the US market had proven to have the highest returns among any countries' equity market. With the US being the world's biggest economy and largest stock market, it provides the room for the world's top companies and business to grow and flourish, making it an ideal choice to invest for long-term growth. However, as with any investment, higher returns come at a higher risk. With the US market and economy being so big already, the room to grow is definitely less compared to decades ago. Also, with other developing countries like China catching up, the US economy may soon no longer be the world's largest economy (and stock market). Hence for investors bearish on longer-term performance of the US market and economy, it would be wise to allocate less to the US and more to the MSCI World Index or even other indexes. However, personally, I would still allocate a portion to the US market given the strong growth prospects and momentum it offers compared to many other markets like SG, China or HK.
4. SG Banks
In recent years, the three local banks in Singapore have been performing extremely well, contributing to most of the gains in the STI. The high interest rate environment has boosted the three banks' profitability and earnings growth, allowing them to pay out more generous dividends (around 6%) to investors. The three big banks are also very well-capitalised and well-regulated by MAS unlike many other foreign banks. Having an exposure (but not an overexposure) to the three local banks would provide a good income-generating portion to any investment portfolio, more so given that dividends paid out by SG companies are tax-exempt unlike many other countries. In terms of price appreciation, I personally believe that the upside is limited and would invest in the bank solely for their dividends, leaving any capital price appreciation as a pure bonus. Being well-managed with strong balance sheets is an even greater incentive to invest in them for dividends as well as greater peace of mind compared to many other SG dividend-paying stocks that often see declines and fluctuations in their dividends. While the SG banks prices are higher than compared to their pre-pandemic prices, their earnings and dividends have also increased by a lot since then. In other words, while we may be paying a somewhat higher price for the banks now, their current valuations are still fairly priced especially given that they are earning more than previously. With a dividend yield of around 6% compared to 4%-5% pre-pandemic, it is reasonable considering we can only get around 3.6%-3.8% risk-free.
The banks' dividend yield is also comparable to what many REITs are giving (especially considering that they are paying out a much higher percentage of their earnings as dividends). While it is not an apple-to-apple comparison, looking solely at their earnings (P/E ratio) and dividend yield, the banks provide much better value than most REITs. However, with that being said, it is still good to diversify a small portion of our investment portfolio to REITs as well (see below under my rationale for REITs).
"It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price." — Warren Buffet
5. REITs
REITs are something good to have but something which one should not overallocate to. A small allocation is sufficient for some exposure. When interest rates recover, REITs will naturally recover (assuming that they are good quality ones). However in the current elevated interest rate environment, REITs are likely to underperform the broader market. Thus, it would be wise to not overallocate to them. Meanwhile, the three Singapore banks offer better earnings and dividends growth, translating into higher capital price appreciation as well compared to our local REITs.
It is important to note that given the huge variety of REITs in Singapore, buying a REITs ETF may be the better option for most investors as compared to picking individual REITs (especially as we have seen in some cases where the REITs have collapsed more than 70% to 90%, while showing little signs of recovery). Unless one is willing to spend the time and effort researching on the individual REITs, simply buying the ETF is would be better for many, especially if your allocation to REITs is relatively small (≤10%) and you do not wish to spend too much time researching into it. My rationale for allocating 10% to REITs regardless of the portfolio type is that REITs are still a decent income-generating asset to have in one's portfolio, and given that most REITs prices are currently severely depressed, the upside for capital appreciation is there. Assuming a 30% to 50% recovery in their prices once interest rates drop, this would translate into a larger % allocation to REITs in the portfolio.
Thus, I personally believe allocating around 10% (+/- 5% depending on personal preference and risk-appetite) to REITs is sufficient for us to have exposure to the potential capital appreciation from the price recovery of REITs while also collecting a meaningful amount of dividends without overallocating too much into REITs. If given a choice between the SG banks and REITs, I still would pick the SG banks. But ideally, we should diversify because we can never be absolutely sure which will outperform in terms of dividends and capital appreciation in the long-term. For now, I see banks providing being a stronger candidate for dividends while REITs being a stronger candidate for capital price appreciation. Having sufficient exposure to both will allow us to win both regardless of their performance.
Some further points:
SG banks + REITs on average pay 5% of dividends per year.
So in the aggressive portfolio, the 35% total allocated to SG banks + REITs will yield 5% x 35% = 1.75% per year which is enough to refill the "warchest" of the aggressive portfolio in 6 years (1.75% x 6 = 10.5%). By ploughing back the dividends into the MSCI, SPY, QQQ, DIA or even SG banks and REITs, you can grow/maintain the aggressive portfolio's composition of equities versus bonds/cash. Alternatively, you could keep the dividends in cash and park them in T-bills, SSB, bonds or high interest savings accounts to grow the bonds/cash component of the portfolio over time, shifting it from an aggressive to a more moderate and passive portfolio as you age. For example, you are 40 years old now with an aggressive portfolio, and you save 50% of the dividends accumulated from the SG banks + REITs. Over time, your bonds/cash component will grow % wise and eventually become like a passive portfolio as you age and near retirement age. In that sense, the aggressive portfolio is designed to automatically evolve into a more moderate and passive portfolio over time if you do not reinvest the dividends. This is intentional by design to ensure that over the years as you approach retirement, your portfolio allocated more to bonds/cash and less to equities. Alternatively you could plough the dividends 100% back into SG banks + REITs to generate even more dividends to further grow your passive income portfolio and hence reducing the degree of aggressiveness in your portfolio which is more suitable for retirement.
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Disclaimer:
The content and information provided on this blog is solely for educational and informational purposes, and should not be construed as financial advice. The accuracy or completeness of the content and information provided in the blog cannot be guaranteed. Before making any investment decisions, it is important for readers to research and carry out independent verification of the information provided, or consult with a qualified financial professional. No warranty and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of actions taken based on the ideas or information found in this blog.
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