How to Create a Passive Investment Portfolio

How to Create a Passive Investment Portfolio

If you have read books and articles on investing, you will have no doubt read about the need for creating a diversified portfolio.

This article discusses how one could hypothetically construct a passive investment portfolio in Singapore.

A portfolio is basically your collection of invested financial assets and securities, also known as your holdings.

Passive investing is for people who do not like or want to spend all their time investing but still look forward to growing their money over time. Passive investors do not attempt to profit from short-term movements in the market.

So, a passive investor’s portfolio is very different from an active investor’s, whose portfolio is actively monitored and managed, possible daily.

If you are a new investor, it will be useful for you to be familiar with basic investing concepts, the strategy of asset allocation and portfolio strategies.

investment_portfolio

A passive investment portfolio generally follows the following strategies:

1) The portfolio is diversified across different asset classes to reduce risk and optimize the portfolio as a whole.

2) The equity portion of the portfolio is largely made up of broad-based low cost index mutual funds or ETFs

3) The asset allocation of a portfolio is apportioned based on an individual’s investment goals, risk tolerance and time horizon.

Based on the above strategies and assuming the investor is moderately aggressive as well as investing for the long-term (20 years or more), he might construct the following portfolio with the following asset allocation:

60% Equity (Stocks)

20% Bonds

10% Gold

10% Cash and/ or Cash Equivalents

Based on the above allocation and an investment principle sum of $50,000, the investor can take the following action steps to create the portfolio.

Assuming all the necessary accounts have been set-up, he will login to his stock broker’s online trading account, search for the following securities via their symbols and purchase them.

60% Equity (Stocks) – $30,000

Following the strategy of investing in broad-based low cost index mutual funds or ETFs as well as diversification, the investor can divide his 60% equity allocation into 3 parts to mitigate risk.

Since there are no broad-based low cost index funds available in Singapore currently, he will invest in the following 3 ETFs:

1) 20% ($10,000) in the SPDR STI ETF (Symbol ES3). 

The STI ETF tracks the index of the top 30 largest companies in Singapore. As an index, it is not considered broad-based or very diversified because it is made up of only 30 companies and 6 companies alone make up 50% of the holdings of the ETF. However, the STI is the only index we have so it will have to do for the investor’s purposes; assuming he is a Singaporean intending to retire in Singapore.

Alternatively, if the investor prefers a wider exposure, he can instead invest in the CIMB FT ASEAN40 ETF (Symbol QS0), although this ETF is slightly less liquid and more volatile than the ES3 ETF. The CIMB FT ASEAN40 tracks an index of the top 40 largest companies in ASEAN (Group of participating counties in South East Asia including Singapore). However, in the long term, the short term volatility would not matter.

Either ETF is fine but the investor would not invest in both as there is a significant percentage of overlap between the largest components of ETFs. Namely, a significant component of both ETFs include holdings in DBS, UOB, Singtel and OCBC.

Investing in both ETFs would not be diversifying one’s portfolio since a significant percentage of both ETFs is the same.

2) 20% ($10,000) in the SPDR S & P 500 ETF (Symbol S27)

This is an even broader based ETF than the STI ETF or CIMB FT ASEAN40. It tracks the index of 500 of the largest companies in the U.S. It offers diversity into the US market.

3) 20% ($10,000) in the Vanguard FTSE All World Excluding the US ETF (Symbol VEU)

This is yet another broad-base Index ETF that will give you exposure to almost 2500 international companies across sectors excluding US companies.

Note: This ETF is not traded on the SGX but in the U.S. on the AMEX. But, it can be bought through your local stock broker’s online trading platform as well (as long as the U.S. market is available for trade, as most brokers would).

The 3 ETFs together give the investor wide exposure to different markets, sectors and companies for a diversified equity allocation.

20% Bonds ($10,000) in the ABF SG bond ETF (Symbol A35)

This is currently the only bond ETF in Singapore and tracks a basket of high-quality bonds issued primarily by the Singapore government and quasi-Singapore government entities.

10% Gold ($5000) in SPDR Gold shares ETF (Symbol O87)

As a hedge against inflation, the investor can invest in gold but as the amount is too little to invest in gold bullion, the investor can buy paper gold in the form of the ETF.

An alternative is to open up a gold savings account with UOB by going down to any of the bank’s branches.

10% Cash ($5000) in a High Interest Savings Account or Money Market Fund

The investor can keep a proportion of his portfolio liquid by keeping cash in a high interest savings bank account or invest in a money market fund through your broker. Some brokers, as Phillip Capital, have a cash management account that automatically invests your excess cash into a money fund.

Lump Sum Investing or Dollar Cost Averaging?

When constructing a passive investment portfolio, the question often asked is whether you should invest your principle investment capital in one lump sum; that is, make the trades all at the same time or dollar cost averaging over a few months. Dollar cost averaging involves investing a fixed sum of money at regular intervals, whether the market is up or down.

One concern investors have regarding lump sum investing is whether the market drops once they invest their entire principle. It is a valid concern but the problem with trying to time the market is that it is almost impossible to do, especially for a new investor. An expert technician (who specializes in technical analysis) might be able to “predict” a good entry time but most people will not be able to do so. Hence, dollar cost averaging is used to avoid timing the market.

pile of money

For passive investors who are looking to invest in the long run, timing the market is not so crucial because you have time on your side. So, short term market fluctuations will not significantly affect your returns in the long run. Therefore, you might as well do lump sum investing to get your portfolio started without delay.

This is especially so if your lump sum is not very big, say $50,000 and below. If the lump sum is not large, then timing the market is really not critical and you should just go ahead to invest the lump sum in constructing your portfolio. Because, if you break up the investment principle into smaller amounts over a few months, you will be paying transaction costs for each of the trades instead of just one. If you have more than $100,000, then you might consider breaking the investments over two to three months to reduce the effects of short time market movements.

One reason why you might dollar cost average your investment principle even if you do not have $100,000 is if the market is currently very volatile. This will require you to be aware of the current financial news and market volatility. If the market is volatile and stock prices are going up and down daily, you might want to consider dollar cost averaging.

Regardless how you invest your principle investment capital, one of the keys to growing your portfolio is to add to your investment capital regularly and reinvest your earnings throughout your investing life. Adding to your investment capital is when a dollar cost averaging approach can work well for you, especially if you are investing for the long term.

Various stock brokers, banks or fund companies offer regular savings plans or monthly investment plans where you can invest as little as $100 a month to buy a stock, mutual fund or ETF. These plans are very “hands-off” and are self-running once you set them up, as long as you have enough money in your specified accounts for the trades to be completed.

 

Disclaimer: This article described a hypothetical portfolio to illustrate how to create a passive investment portfolio. The above should not be viewed as investment advice. The reader should do his/ her own research before making informed decisions on specific investments to make.

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