Someone wrote to me the following comment:
“I invested via Endowus, Sfye, Moneyowl and Stashaway. None of them are doing well. I am very sad. I thought ETFs could weather the storms better than investing in individual stocks.”
Do you resonate with the above statement? If you do, continue to read this newsletter.
One of the main reasons why many investors are not satisfied with their investments is due to not being aware that there are three approaches in investments.
The first approach to investing is known as market returns, where an investor aims to achieve returns that are higher than the returns of a specific market index, such as the S&P 500, MSCI World, or Hang Seng Index. For example, if the market return for a particular year is -50% and an investor's return is -45%, they would be considered successful as they have outperformed the market. Similarly, if the market returns 20% and an investor achieves 24%, they would also be considered successful.
Investments that are used to deliver market returns include stocks, exchange-traded funds (ETFs), and unit trusts that focus on capital gains.
However, it's important to note that just outperforming the market return does not guarantee a positive return for the investor. For example, in 2022, the S&P500 lost nearly 20% and the China market lost 22%. So, if an investor invested in portfolios that were meant to provide market returns, they may not be happy with the negative returns they received. This is because they may not have realized that their personal preferences and the actual investments they made were not compatible. It could be they were either not looking for market returns or they did not realised that market returns are not suitable for them.
Investing in market returns investments can be a viable strategy for some investors because it offers the potential for significant long-term returns. Sophisticated investors who have the knowledge, skill, and emotional fortitude to navigate the ups and downs of the market may choose to invest in market returns portfolios. These investors may believe that over the long-term, the market will provide positive returns and that by investing in a diversified portfolio of stocks, ETFs, or unit trusts that mirror the market, they will be able to capture those returns.
However, it's important to note that investing in market returns investments can also be risky, and the returns may not always be positive in the short-term. This is why, retail investors who do not have the knowledge, skill, and emotional stability to handle the volatility of the market may not be suitable for this type of investment. They may be better off investing in other types of investments that offer more stability and predictability, such as bonds or fixed-income investments.
Cash Flow based returns
The cash flow based approach to investments focuses on generating income from the investments made, rather than primarily focusing on capital gains. This approach is suitable for investors who are retired or wish to supplement their salary with additional income. Examples of cash flow based investments include dividends from stocks, coupons from bonds, and rental income from properties.
In this approach, investors select investments that provide a consistent income stream, such as dividends from blue-chip stocks or interest from bonds, rather than investments that have the potential for high capital gains but also have the potential to be volatile. These types of investments can provide a steady stream of income, which can be used to cover living expenses, pay off debt or make additional investments.
In general, the cash flow based approach is less risky than the capital gains based approach, which is why it is more suitable for investors who are retired or nearing retirement, as well as for those who are looking for a steady income stream to supplement their salary.
Absolute Return investments
The idea of investing without any chance of loss and still achieving positive gains is appealing to many investors, and many retail investors are indeed looking for absolute return strategies, even if they may not be aware of it. Absolute return investments, such as endowment insurance policies, structured notes, bonds held to maturity, and annuities, promise a set return over a certain period of time, regardless of market conditions.
However, it's important to note that absolute return investments are not without cost and risk. Some of the potential risks and costs associated with absolute return investments include:
- Opportunity cost: Many absolute return strategies require a long-term commitment, and the time invested in these strategies could have been used to invest in other instruments that may generate higher returns.
- Liquidity risk: Due to the committed period, investors may not have access to their money until a later date. Many endowment policies impose surrender charges for early termination, which can limit an investor's ability to access their funds.
- Credit risk: Structured notes are often backed by investment banking companies, and if the company goes bankrupt, the investment may be totally wiped out, as seen in the case of Lehman Brothers.
It is important to understand that absolute return investments are not a guarantee of returns, and investors should always be aware of the risks and costs involved before making any investment decisions.
As we have seen, there are three main approaches to investing: market returns, cash flow, and absolute return. In order for an investment to be suitable, it is important for the investor to be self-aware of their preferences, financial goals, and the investments themselves. It is important for the investor to understand their risk tolerance, investment horizon, and cash flow needs.
The important step in selecting suitable investments is to approach a financial advisor. Financial advisors are trained professionals who can help investors identify their preferences, goals, and risk tolerance, and make suitable recommendations based on that information. They can also provide guidance on how to construct a diversified portfolio that aligns with the investor's goals and risk tolerance.
Every investor is unique and has different goals, preferences and risk tolerance. Therefore, one size does not fit all when it comes to investments. A financial advisor can help you understand the different investment options available, and help you select the one that is most suitable for you.
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