Proceed with care in Asian investments

Q: Asian markets are at extremely cheap levels now. Do you think it is a good time for investors to enter this market? 

A: Using the MSCI Asia ex-Japan Index as a gauge, Asian markets are indeed at very attractive valuations. From a price-to-earnings perspective, the market is currently at its lows compared to the last 35 years. Further, from the angle of price-to-book ratio, Asia is also well below its long-term average of 1.8x at current levels.

Despite the cheap valuation, it may be too soon to jump back into a high beta market like Asia: the global headwinds stemming from the crisis in Europe, as well as the slowdown in the US and China, have shown few signs of easing.

However, it is also advisable for investors to maintain a balanced and diversified portfolio during these volatile times. Although risk aversion remains intact, investors interested in gaining exposure to the Asian equity market can consider the defensive sectors. These sectors may help manage downside risk of a portfolio.

Additionally, defensive companies are less sensitive to economic cycles as they produce items that are needed by consumers irrespective of economic circumstances. Another enticing aspect will be that of sustainable dividends which may help ease downward pressure from the market by adding a premium over steady income.

Investors can also consider dollar cost averaging (DCA) to gain exposure to Asian markets. This is a disciplined and convenient approach where investors reduce the need to time the market. In addition, it may help reduce investment costs and boost potential returns when the market turns for the better.

The foundation of successful investing remains educating and familiarising oneself with the various aspects of the market. Investors should also conduct due diligence to back each investment decision. It is also advisable to speak to a qualified financial adviser to truly understand the risk before investing in the market.

Dollar Cost Averaging Method

The Regular Savings Plan (RSP) utilizes the dollar cost averaging (DCA) concept of investing which is the practice of investing a fixed amount of money regularly regardless of market conditions. In the case of RSP, the investments take place monthly. This article helps investor understand the benefits of DCA and what considerations that an investor has to make in executing a dollar cost averaging plan.

The Regular Savings Plan (RSP) utilizes the dollar cost averaging (DCA) concept of investing which is the practice of investing a fixed amount of money regularly regardless of market conditions. In the case of RSP, the investments take place monthly. This article helps investor understand the benefits of DCA and what considerations that an investor has to make in executing a dollar cost averaging plan.

Benefits of Dollar Cost Averaging 

For many investors, market timing of buying low and selling high is almost an impossible task especially when fear and greed typically lead investors to do the opposite of buying high and selling low. The main benefit of DCA is that it takes the guesswork and emotion out of investing. 

By investing a fixed amount on a monthly basis, RSP ensures that you accumulate more units when prices are low but lesser when prices of units are high. A lot of stress is avoided as the investor does not have to decide whether the fund is expensive or not and whether the market condition is suitable to invest. 

Table 1 shows a hypothetical example of how more units are acquired when prices are low and vice versa assuming that an investor invests $100 every month. Chart 1 is the graphical presentation.

Table 1

	Investment amount ($)	*Price ($)	Units Acquired
January	100	1.00	100.00
February	100	1.14	87.72
March	100	0.90	111.11
April	100	1.03	97.09
May	100	0.95	105.26
June	100	0.89	112.36
July	100	1.08	92.59
August	100	1.19	84.03
September	100	0.85	117.65
October	100	0.98	102.04
November	100	1.17	85.47
December	100	0.83	120.48

* Prices are randomly generated

Source: iFAST Compilations

Chart 1

Many investors procrastinate in investing, preferring to accumulate a large sum of money before deciding where to invest. The temptation of spending the sum meant for investments could also derail longer-term financial goals. By deducting a fixed sum of money from the bank account and placing them into funds, RSP also instills discipline in investing. 

This helps investors steadily move towards their financial goals. Moreover, with investors now starting young, many may not have the luxury of investing a large lump sum. RSP becomes a practical method of "invest-as-you-earn".

Lump sum investing would be better for investors with long investment horizon 

DCA is a strategy that works well in a market environment that is volatile, experiencing both upswings and downswings but ends at a level that is close to the initial level. However, historical data shows that most stock markets do exhibit an uptrend over the long term. 

This means that for investors who have a large sum of money to start their investments with and coupled with a long term investment horizon, they would be better off investing the money right away (refer to " Long-Term Investing Works").

Although lump sum investing works better than DCA assuming that stock markets continue their long-term uptrend, investors are often paralyzed with fear in times of heightened volatility such that they put off investing. These investors can consider DCA in such times to start their investments. 

By breaking the lump sum into smaller parts, investors can view it as a chance to average down their costs when markets move down. On the other hand, if the markets move up subsequently, investors would have already invested part of their money. 

The main benefit of DCA in times of heightened volatility is that it helps investors overcome the fear of investing in turbulent markets.

Now that we have explained the benefits of DCA, the following steps would help the investor execute the method of DCA through RSP.

Actions to take for RSP

• Decide on the monthly amount that can be sustainable over the investment horizon

• Select the funds to invest into, making sure that portfolio is diversified.

• Rebalance your funds at least annually to ensure that your portfolio remains diversified

• Wait for your investments to reap rewards. 

The Magic Of Compounding

Compound interest, a vital component of regular investing, can help you achieve your financial goals, such as becoming a millionaire, retiring comfortably or being financially independent.

When you were a kid, perhaps one of your friends asked you the following trick question: "Would you rather have $10,000 per day for 30 days or a penny that doubled in value every day for 30 days?" Today, we know to choose the doubling penny, because at the end of 30 days, we'd have about $5 million versus the $300,000 we'd have if we chose $10,000 per day.
Compound interest is often called the eighth wonder of the world, because it seems to possess magical powers, like turning a penny into $5 million. The great part about compound interest is that it applies to money, and it helps us to achieve our financial goals, such as becoming a millionaire, retiring comfortably, or being financially independent.

The components of compound interest

A dollar invested at a 10% return will be worth $1.10 in a year. Invest that $1.10 and get 10% again, and you'll end up with $1.21 two years from your original investment. The first year earned you only $0.10, but the second generated $0.11. This is compounding at its most basic level: gains begetting more gains. Increase the amounts and the time involved, and the benefits of compounding become much more pronounced.Compound interest can be calculated with the following formula:

FV = PV (1 + i)^N

FV = Future Value (the amount you will have in the future)

PV = Present Value (the amount you have today)

i = Interest (your rate of return or interest rate earned)

N = Number of Years (the length of time you invest)

Who wants to be a millionaire?

As a fun way to learn about compound interest, let's examine a few different ways to become a millionaire. First we'll look at a couple of investors and how they have chosen to accumulate $1 million.

1. Jack saves $25,000 per year for 40 years.

2. Jeff starts with $1 and doubles his money each year for 20 years.

While most would love to be able to save $25,000 every year like Jack, this is too difficult for most of us. If we earn an average of $50,000 per year, we would have to save 50% of our salary!

In the second example, Jeff uses compound interest, invests only $1, and earns 100% on his money for 20 consecutive years. The magic of compound interest has made it easy for Jeff to earn his $1 million and to do it in only half the time as Jack. However, Jeff's example is also a little unrealistic since very few investments can earn 100% in any given year, much less for 20 consecutive years.

TIP: A simple way to know the time it takes for money to double is to use the rule of 72. For example, if you wanted to know how many years it would take for an investment earning 12% to double, simply divide 72 by 12, and the answer would be approximately six years. The reverse is also true. If you wanted to know what interest rate you would have to earn to double your money in five years, then divide 72 by five, and the answer is about 15%.

Time is on your side

Between the two extremes of Jeff and Jack, there are realistic situations in which compound interest helps the average individual. One of the key concepts about compounding is this: The earlier you start, the better off you'll be. So what are you waiting for?

Let's consider the case of two other investors, Luke and Walt, who'd also like to become millionaires. Say Luke put $2,000 per year into the market between the ages of 24 and 30, that he earned a 12% after-tax return and that he continued to earn 12% per year until he retired at age 65. Walt also put in $2,000 per year, earned the same return, but waited until he was 30 to start and continued to invest $2,000 per year until he retired at age 65. In the end, both would end up with about $1 million.

However, Luke had to invest only $12,000 (i.e., $2,000 for six years), while Walt had to invest $72,000 ($2,000 for 36 years), or six times the amount that Walt invested, just for waiting an additional six years to start investing.

Clearly, investing early can be at least as important as the actual amount invested over a lifetime. Therefore, to truly benefit from the magic of compounding, it's important to start investing early. We can't stress this fact enough! After all, it's not just how much money you start with that counts, it's also how much time you allow that money to work for you.

In our first example, Jack had to save $25,000 a year for 40 years to reach $1 million without the benefit of compound interest. Luke and Walt, however, were each able to become millionaires by saving only $12,000 and $72,000, respectively, in relatively modest $2,000 increments. Luke and Walt earned $988,000 and $928,000, respectively, thanks to compound interest. Gains beget gains, which beget even larger gains. This is again the magic of compound interest.

Why is compound interest important to investing?

In addition to the amount you invest and an early start, the rate of return you earn from investing is also crucial. The higher the rate, the more money you'll have later. Let's assume that Luke from our previous example had two sisters who, at age 24, also began saving $2,000 a year for six years. But unlike Luke, who earned 12%, sister Charlotte earned only 8%, while sister Rose did not make good investment decisions and earned only 4%.

When they all retired at age 65, Luke would have $1,074,968, Charlotte would have $253,025, and Rose would have only $56,620. Even though Luke earned only 8 percentage points more per year on his investments, or $160 per year more on the initial $2,000 investment, he would end up with about 20 times more money than Rose.

Clearly, a few percentage points in investment returns or interest rates can mean a huge
difference in your future wealth. Therefore, while stocks may be a riskier investment in the short run, in the long run the rewards can certainly outweigh the risks.

The bottom line

Compound interest can help you attain your goals in life. In order to use it most effectively, you should start investing early, invest as much as possible, and attempt to earn a reasonable rate of return.