[SINGAPORE] Most of us understand the benefits of investing for the future and what the different asset classes are. There are also different investment vehicles available to us – for instance, mutual funds, exchange-traded funds (ETFs) and individual stocks – each with its relative strengths and weaknesses.
However, given the plethora of options, this is also where investors can get caught in the weeds and give up. So how do we avoid falling into this trap?
Well, let’s assume that you have decided to use ETFs as your go-to vehicle for equity investments. How do you then try to pick from the thousands of options available to you? There are three questions you need to answer.
Which markets to invest in
Alternatively, you might want to have a higher exposure to the US technology sector. In this case, an allocation to the Nasdaq index might make sense, although the top five companies account for a third of this index.
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Of course, you might be aware of the benefits of geographical diversification. So, you look at ETFs based on stock indices, such as EuroStoxx 50, the UK’s FTSE 100 (or FTSE 250, if you want more exposure to the UK economy rather than the UK’s export-oriented companies), Japan’s Topix, and either the MSCI Asia ex-Japan or the MSCI Emerging Market index.
Once you have decided on this, you can consider how to allocate between the different options. Try not to overthink this. Getting something approximately right is good enough. You can use our asset allocation models as a starting point before refining your choice based on your own preferences.
What to look for in an ETF
There are three really important things: The first thing to consider is the tax efficiency of the ETF. For instance, for a non-US investor, a UCITS-compliant ETF might be more tax efficient than a US-based ETF (for instance, for the S&P 500 index, the VOO ETF may be preferred over the SPY ETF).
Second, look at the expense ratio. Remember the main reason for choosing an ETF in the first place is its cost efficiency. Therefore, you might as well choose one with a lower cost, assuming the ability of the ETFs to track your chosen index is similar.
Third, the minimum investment amount required. For many investors, especially those just starting out on their investment journey, their available amount to invest can be quite small. But fret not, as more and more ETFs allow for lower minimum investments (for example, SPLG), which can make this more manageable.
How to invest: lump sum, dollar-cost or value-cost averaging
The final part of the puzzle is the strategy to deploy your hard-earned money into the selected ETFs over time. There are three main ways to do this.
First, via a lump-sum investment – that is, invest all the money at one go. Theoretically and probabilistically, this is the best approach. However, having some cash on the sidelines to invest is a great emotional hedge, especially if markets weaken and assets go on sale.
This leads to the other two options – dollar-cost averaging and value-cost averaging. The former is the more well-known of the two strategies; it basically involves investing a fixed dollar amount every month.
The value-cost averaging approach means you have a target value for your portfolio over time. You then calculate the value of investments required, based on today’s pricing, to get there.
If the value of your portfolio increases, then you reduce the amount you invest; if the value falls, then you increase the size of investment. For instance, if the target value of your investments is US$1,200 in a year’s time, and you start with a US$300 investment. After three months, you revisit and see that the value is US$320. If it is worth US$320, you would need to invest only US$280 in the coming period. However, if the value falls to US$550 three months later, you would need to invest US$350 to get back on track.
The benefit of this approach is that you increase your investment quantum when markets go on sale, and lower it if markets perform well – effectively buying low and slowing investments (or potentially selling) when markets are high.
Of course, as with any plan, the key is execution. We know that the best time to invest is yesterday, the second-best time is today. Therefore, it is important to just get started and then learn on the job, refining your investment deployment approach and precise asset allocation over time.
The writer is global chief investment officer at Standard Chartered Bank’s wealth solutions unit