There was some discussion on preference shares on my favorite financial blog. Here are my thoughts regarding this topic.
Someone wrote: I read in Benjamin Graham's The Intelligent Investor that the best time to buy them is during market turmoil when prices are depressed. )
Yes, I remembered that Benjamin Graham did mention that preference shares are to be bought on a depressed basis. Preference shares have certain characteristics that make it even more necessary to buy them on a depressed price than common shares.
When bought at or above par value (SGD100 in Singapore's context), preference shares do not take part in the profitable growth of the company. The company can announce 50%-100% profit growth, but the price of the preference shares will move up only a little. If you bought the common shares, it is possible to earn capital appreciation of more than 20% with this kind of performance. To appreciate this point, compare the price charts of UOB shares and UOB 5.05% NCPS from Mar 2008 onwards.
However, if you bought on a depressed price well below par value, the preference shares do participate in the growth of the company until the price reaches par value (but rise slowly after this point). When you buy preference shares on a depressed price, you enjoy both higher dividend yield and capital appreciation if the company recovers.
The best reason for not buying preference shares at non-depressed levels (above par) is that they decline more in adversity but do not rise much in prosperity. The dividends from preference shares are discretionary, not obligatory as in the case for bonds. Discretionary expenses are usually the first to be cut when a company is struggling. Hence, when the company starts announcing poor financial results, the fear of dividend cuts can drive the price down significantly. In any case, it is most likely to fall below par value.
Look at the price chart of the bank preference shares in 2008 and early 2009 to appreciate this point. In investing, if the downside exceeds the upside, you don't invest.
Also, when the banks redeem the preference shares, they will redeem it at par. So, if you bought the preference shares above par, you suffer a guaranteed loss in principal upon redemption. The dividends can cover this loss provided you have at least held the preferences shares for some time and the bank did not redeem the shares. Please at least check the date from which the bank has the option for redemption. I would not buy a preference share above par near the redemption date.
Now that most preference shares are trading above par, I personally will not buy them. Unfortunately, I was not smart enough to buy them in 2008 and early 2009 on a depressed basis. So much for talk only.
Sunday, July 25, 2010
Sunday, April 18, 2010
Safer ways of building retirement nest egg
Whenever the topic of building a comfortable retirement nest egg turns up, investing is almost always mentioned. Personally, I would not put investing at the top of the list of recommendations to build retirement fund to the general public. It will be a disaster if your investment gets wiped out just when you are about to retire. In fact, this did happen and the person got so aggrieved that he suggested that CPF funds be banned for investment.
There are less risky ways which I highly recommend to achieve financial independence. They are slower but surer. However, they will not make you very rich but will allow you to retire with dignity and avoid becoming a burden to society. The methods are as follows;
1. Saving money
Unlike investing where luck plays a role (at least in the short-term), saving money is within anyone's control. A middle-income person with financial discipline should be able to set aside at least 10% of their salary per month. Assuming there is no extended period of unemployment, the person should be able to accumulate a respectable nest-egg by the time he retires. My next series of posts will be on saving.
2. Using insurance for protection
Saving money alone is not enough as an unexpected disaster can take them away. You can lead a frugal lifestyle and save lots of money. However, without insurance protection, you can still be bankrupted by unexpected disasters like medical illnesses or accidents that hits you with a huge bill and disables you from earning an income for an extended period of time.
Therefore, it is prudent to buy insurance to transfer such risks away.
3. Work hard at your job and be good at it
For the majority of us, our major source of income comes from our job. Not many of us can have investment income that exceed our salary. Hence, it makes sense to concentrate your efforts on doing a good job in your career rather than dream of the day when you can shake leg and solely depend on your passive investment income.
Many people have said that one cannot get rich being a salary worker. That depends on who you are talking to. Fund managers, bankers, proprietary traders will disagree. People who work in the highly competitive consumer electronics sector (like me) whose profit margins get squeezed and major companies moving out to China every year will agree. The lesson learnt is to join the right industry. The right industry is the one with the highest median salary.
Speaking from experience, I have seen mediocre people working in the right industry getting paid more than smart people working in a bad industry. If someone is in the right place at the right time, he can work less hard and be less smart and yet earn much more than someone who works very hard and is very smart.
Choosing the right industry is a matter of luck. My advice to fresh graduates is not to choose a job simply because it pays well and end up becoming miserable. I believe it is more important to choose a job suited to your personality and natural abilities so that you can perform well and even come to love it.
4. Arm yourself with financial knowledge to protect against the financial sharks
In a modern economy in which financial services have become dominant, it is important to be financially literate to protect yourselves against the financial sharks who work in this industry. The compensation of Wall-Street kind of jobs is so out of whack with reality that I have to wonder about the source of their income. One income source is the financially illiterate suckers that they prey upon. You can do the right things financially all your life - saving hard and working hard. Without adequate financial knowledge, one commission-minded financial adviser intent on sucking you dry will succeed in persuading you to part with your hard-earned nest-egg. Remember the Lehman Brothers Minibonds?
Sunday, April 11, 2010
Financial literacy is the most effective shield against financial sharks
During the heights of the financial crisis of 2008, a recurring conversational topic were the financial sharks who got rich out of preying on the hard-earned savings of ignorant consumers.
I got some heat when I defended the young relationship managers hired by the banks to meet aggressive sales quota. I did not like the way people called them immoral and greedy. Abhorrent their behavior may be, how they behaved is similar to how the average person would have behaved given the same set of carrots and sticks.
The people at the financial institutions are the ones who are best armed with knowledge to teach financial literacy. However, the unfortunate reality is that they have the least incentives to teach financial literacy but every motivation to spread financial ignorance and even disinformation. When you think about the financial products they sell, maximum profit is made from the ignorance of consumers. It is hard to sell high commission products to a financially literate person. The most lucrative customer (or sucker) is a rich, ignorant and greedy one. Hence, it is small wonder the retirees are an unspoken favorite target group of the financial sharks.
Ignorance is something all of us can improve on. You do not need to be highly intelligent to conquer it. Conquering it can at least protect the public from making basic financial mistakes like chalking up high credit-card debts to legalized loan-sharks. This is a fast route to bankruptcy. School teachers should use credit-card debts as an example to teach compound interest. This simple act might have saved some of their students from credit-card bankruptcy when they grow up.
It is more effective to work on one's ignorance than to blame "immoral" bankers who are being business-like in maximizing profits.
Another group that often gets the blame during the discussions are the regulators. On hindsight, deregulating the financial sector by Alan Greenspan and expecting the banks to self-regulate was a mistake. In my humble opinion (pardon me if you know better as I do not have a financial background), the mistake made was in expecting that it was in the interests of banks to self-regulate and not commit financial suicide. Actually, it was in the interest of the bankers to take excessive risks, earn excessive bonuses while the dancing carries on, then when the dancing stops, get taxpayers to pick up the tab and eject with a golden parachute (another round of excessive bonus). It was the smartest way to play the game and this is what you would expect when the brightest minds in the world move into the financial sector. This was clearly a case in which the free market fails. Regulators do have an important role to play in situations when the free market fails. Therefore, the solution to the financial crisis must come from the regulators, not bankers. More regulation, not less regulation.
Some victims of the Lehman Minibonds debacle insisted that the regulators should have protected them from the financial sharks. For practical reasons, I do not think it is wise for the public to depend on more regulation for protection.
There are powerful forces set against the regulators to legislate financial reforms. With the money that the financial services industry can muster, they can exert enormous political pressure on the regulators. Given the important role that bankers play in the economy, they will know powerful friends in high places. With their money, they might even have senior politicians in their pocket. They have many trump cards to play with. You can be sure they will play their cards very well as the excessive bonuses doled out will attract the finest minds in the world. Because of the much higher compensation, the regulators are up against superior minds. These problems are not as serious in Singapore as the civil service is known to be relatively corruption-free, fairly well-paid and therefore attracts its fair share of the bright minds in the country.
However, excerpts of this video (scroll to 0:56:34) show that even the most powerful, smartest politician of America with kind intentions to do good for her country has to eventually bow to the political might the financial sharks possess. The politician in context was none other than Mrs Hillary Clinton.
Certain hiring practices of the financial industry (in US) can "corrupt" even the best regulatory system designed with best practices to be incorruptible. By hiring regulators and paying them ridiculous sums of money to leave the job, bankers have carved out a most lucrative career path for the regulators. Existing regulators, consumed with envy and jealousy of the new-found wealth of their former colleagues, will see the bankers as their future bosses. Immense riches shall come to them once they too have successfully made the jump. They have to be careful not to set regulations that hurt the bank's profits because it is not in their interests to hurt their own future profits. In fact, it is in their interests to remove current regulations that crimp their future bosses' profits. If this can happen in the US, it can happen in Singapore some day because human nature is the same everywhere. Can the people safely depend on their regulators to set policies that protect them?
Hence, the most effective shield the public can use to protect against the financial sharks is to count on themselves in acquiring financial literacy. One of our own regulators, the CPF board, has commendably been doing this job as a service to the public. Please visit their financial literacy website http://www.imsavvy.sg.
Another good site which I highly recommend is http://tankinlian.blogspot.com which requires no introduction for Singaporeans. He is a rare breed who speaks out for people at the expense of his own interest without fear of offending powerful forces related to the financial industry.
I got some heat when I defended the young relationship managers hired by the banks to meet aggressive sales quota. I did not like the way people called them immoral and greedy. Abhorrent their behavior may be, how they behaved is similar to how the average person would have behaved given the same set of carrots and sticks.
The people at the financial institutions are the ones who are best armed with knowledge to teach financial literacy. However, the unfortunate reality is that they have the least incentives to teach financial literacy but every motivation to spread financial ignorance and even disinformation. When you think about the financial products they sell, maximum profit is made from the ignorance of consumers. It is hard to sell high commission products to a financially literate person. The most lucrative customer (or sucker) is a rich, ignorant and greedy one. Hence, it is small wonder the retirees are an unspoken favorite target group of the financial sharks.
Ignorance is something all of us can improve on. You do not need to be highly intelligent to conquer it. Conquering it can at least protect the public from making basic financial mistakes like chalking up high credit-card debts to legalized loan-sharks. This is a fast route to bankruptcy. School teachers should use credit-card debts as an example to teach compound interest. This simple act might have saved some of their students from credit-card bankruptcy when they grow up.
It is more effective to work on one's ignorance than to blame "immoral" bankers who are being business-like in maximizing profits.
Another group that often gets the blame during the discussions are the regulators. On hindsight, deregulating the financial sector by Alan Greenspan and expecting the banks to self-regulate was a mistake. In my humble opinion (pardon me if you know better as I do not have a financial background), the mistake made was in expecting that it was in the interests of banks to self-regulate and not commit financial suicide. Actually, it was in the interest of the bankers to take excessive risks, earn excessive bonuses while the dancing carries on, then when the dancing stops, get taxpayers to pick up the tab and eject with a golden parachute (another round of excessive bonus). It was the smartest way to play the game and this is what you would expect when the brightest minds in the world move into the financial sector. This was clearly a case in which the free market fails. Regulators do have an important role to play in situations when the free market fails. Therefore, the solution to the financial crisis must come from the regulators, not bankers. More regulation, not less regulation.
Some victims of the Lehman Minibonds debacle insisted that the regulators should have protected them from the financial sharks. For practical reasons, I do not think it is wise for the public to depend on more regulation for protection.
There are powerful forces set against the regulators to legislate financial reforms. With the money that the financial services industry can muster, they can exert enormous political pressure on the regulators. Given the important role that bankers play in the economy, they will know powerful friends in high places. With their money, they might even have senior politicians in their pocket. They have many trump cards to play with. You can be sure they will play their cards very well as the excessive bonuses doled out will attract the finest minds in the world. Because of the much higher compensation, the regulators are up against superior minds. These problems are not as serious in Singapore as the civil service is known to be relatively corruption-free, fairly well-paid and therefore attracts its fair share of the bright minds in the country.
However, excerpts of this video (scroll to 0:56:34) show that even the most powerful, smartest politician of America with kind intentions to do good for her country has to eventually bow to the political might the financial sharks possess. The politician in context was none other than Mrs Hillary Clinton.
Certain hiring practices of the financial industry (in US) can "corrupt" even the best regulatory system designed with best practices to be incorruptible. By hiring regulators and paying them ridiculous sums of money to leave the job, bankers have carved out a most lucrative career path for the regulators. Existing regulators, consumed with envy and jealousy of the new-found wealth of their former colleagues, will see the bankers as their future bosses. Immense riches shall come to them once they too have successfully made the jump. They have to be careful not to set regulations that hurt the bank's profits because it is not in their interests to hurt their own future profits. In fact, it is in their interests to remove current regulations that crimp their future bosses' profits. If this can happen in the US, it can happen in Singapore some day because human nature is the same everywhere. Can the people safely depend on their regulators to set policies that protect them?
Hence, the most effective shield the public can use to protect against the financial sharks is to count on themselves in acquiring financial literacy. One of our own regulators, the CPF board, has commendably been doing this job as a service to the public. Please visit their financial literacy website http://www.imsavvy.sg.
Another good site which I highly recommend is http://tankinlian.blogspot.com which requires no introduction for Singaporeans. He is a rare breed who speaks out for people at the expense of his own interest without fear of offending powerful forces related to the financial industry.
Sunday, April 4, 2010
Importance of emergency cash reserves
I have a policy of keeping sufficient cash reserves to meet life's misfortunes. The common risks in life that I can think of are unemployment, medical illnesses, accidents. Risks such as medical illnesses and accidents can be transferred away through insurance. Insurance premiums are fixed costs, so they make financial planning easier as they bring more certainty to the specific risks. This helps one to reduce the size of the cash reserves to be set aside. Generally, when the risks are more uncertain, one has to set aside a larger cash buffer for protection.
In the event of unemployment, I set aside 6 months worth of cash to meet expenses which cannot be avoided. This includes basic living expenses, debt payments and parents' allowances. Although my parents will probably refuse to accept any money should I become unemployed, I think it is a good policy to set aside this money anyway. Children have a greater chance of becoming filial when they grow up when the parents exhibit similar behavior themselves. Therefore, undisrupted payment of parents' allowances despite adversity is a good policy of securing one's retirement in old age because it nurtures filial children who provide retirement support.
As a person grows older, I think 6 months worth of cash will not be sufficient for protection. For the average worker, it is harder to find a job if he gets retrenched at an older age and even when he does, a pay cut is almost inevitable. Therefore, he should set aside at least 10-15 months worth of funds as he grows older depending on how confident he is in finding new sources of income soon.
Besides unemployment, there are other risks in life that cannot be insured away. One risk that presents particular headache to me is parents' and parents'-in-law medical bills as they near the end of their lives. It is very hard to estimate how much this will cost because it depends on how they die. If they were to die a slow death, organ by organ, the doctors will eat up my nest-egg. Because of the uncertainty, one has to set aside an out-sized amount. It is a burden that one has to carry to avoid the regret and guilt of causing the old folks' deaths by denying them medical care. The younger generations of Singaporeans will have to bear even heavier burdens as parents have fewer kids and their life expectancy lengthens. It is incumbent on every parent to start preparing for their retirement to prevent such issues from souring family relationships.
On top of the cash reserves that I set aside for the above considerations, I added another 10%-15% as a margin of safety to meet life's unknown or even unexpectable risks. I think this is reasonable because no one can think of all the possible risks ahead.
Those who invests in the stock market may be tempted to put the emergency cash reserves into it. Indeed, I was tempted when I started out in the stock market. Thankfully, I did not. Like most amateurs, I lost money. However, at no time did I put my family finances in danger because the cash reserves were untouched. An advantage of having ample cash backup is the psychological support it provides which gave me a cool head while others in the same predicament were losing theirs. This is very important in investing as the right psychology plays a big role in success. An investor who becomes disheartened by losses will not be able to recover his losses when the bull market returns.
Some newbie investor will ask "what if they do not have such a cash reserve"? Then, don't invest. My order of priority is to first, buy insurance for protection, then save hard to build up a sufficient cash reserve and finally, invest the rest which represents money that can be lost 100% without danger to the family's finances.
In the event of unemployment, I set aside 6 months worth of cash to meet expenses which cannot be avoided. This includes basic living expenses, debt payments and parents' allowances. Although my parents will probably refuse to accept any money should I become unemployed, I think it is a good policy to set aside this money anyway. Children have a greater chance of becoming filial when they grow up when the parents exhibit similar behavior themselves. Therefore, undisrupted payment of parents' allowances despite adversity is a good policy of securing one's retirement in old age because it nurtures filial children who provide retirement support.
As a person grows older, I think 6 months worth of cash will not be sufficient for protection. For the average worker, it is harder to find a job if he gets retrenched at an older age and even when he does, a pay cut is almost inevitable. Therefore, he should set aside at least 10-15 months worth of funds as he grows older depending on how confident he is in finding new sources of income soon.
Besides unemployment, there are other risks in life that cannot be insured away. One risk that presents particular headache to me is parents' and parents'-in-law medical bills as they near the end of their lives. It is very hard to estimate how much this will cost because it depends on how they die. If they were to die a slow death, organ by organ, the doctors will eat up my nest-egg. Because of the uncertainty, one has to set aside an out-sized amount. It is a burden that one has to carry to avoid the regret and guilt of causing the old folks' deaths by denying them medical care. The younger generations of Singaporeans will have to bear even heavier burdens as parents have fewer kids and their life expectancy lengthens. It is incumbent on every parent to start preparing for their retirement to prevent such issues from souring family relationships.
On top of the cash reserves that I set aside for the above considerations, I added another 10%-15% as a margin of safety to meet life's unknown or even unexpectable risks. I think this is reasonable because no one can think of all the possible risks ahead.
Those who invests in the stock market may be tempted to put the emergency cash reserves into it. Indeed, I was tempted when I started out in the stock market. Thankfully, I did not. Like most amateurs, I lost money. However, at no time did I put my family finances in danger because the cash reserves were untouched. An advantage of having ample cash backup is the psychological support it provides which gave me a cool head while others in the same predicament were losing theirs. This is very important in investing as the right psychology plays a big role in success. An investor who becomes disheartened by losses will not be able to recover his losses when the bull market returns.
Some newbie investor will ask "what if they do not have such a cash reserve"? Then, don't invest. My order of priority is to first, buy insurance for protection, then save hard to build up a sufficient cash reserve and finally, invest the rest which represents money that can be lost 100% without danger to the family's finances.
Saturday, March 20, 2010
Handling financial product promoters
Lately, my phone has been bombarded with calls from strangers to promote financial products. I normally tell them "Sorry, I am not interested" and hang up the phone.
If the financial products are aggressively sold to me, I reject it outright. I do not want to spend any more time to learn about it.
If someone aggressively promotes a financial product, he is usually getting paid handsome commission for it. This commission comes out of your pocket when you buy the product. A good deal for the seller is usually a bad deal for the buyer. Good financial deals never come looking for you. You have to actively seek them out yourself. If somebody knows of a wonderful bargain, he is going to buy all that he can himself. The last thing he wants to do is to let the secret out. The next time you hear of a deal-you-can't-miss from a stranger, just walk away. He is somebody you better miss.
This is why I never buy products sold by the bank relationship managers. In fact, the sort of financial products they sell can be used as a contrarian indicator. In the early part of 2008, commodity investment funds were popularly sold by the banks. Commodity prices collapsed in the later part of 2008.
The next time you receive cold calls from strangers selling financial products, just hang up. Time is better spent hunting for the best deals yourself than expecting good deals from strangers.
If the financial products are aggressively sold to me, I reject it outright. I do not want to spend any more time to learn about it.
If someone aggressively promotes a financial product, he is usually getting paid handsome commission for it. This commission comes out of your pocket when you buy the product. A good deal for the seller is usually a bad deal for the buyer. Good financial deals never come looking for you. You have to actively seek them out yourself. If somebody knows of a wonderful bargain, he is going to buy all that he can himself. The last thing he wants to do is to let the secret out. The next time you hear of a deal-you-can't-miss from a stranger, just walk away. He is somebody you better miss.
This is why I never buy products sold by the bank relationship managers. In fact, the sort of financial products they sell can be used as a contrarian indicator. In the early part of 2008, commodity investment funds were popularly sold by the banks. Commodity prices collapsed in the later part of 2008.
The next time you receive cold calls from strangers selling financial products, just hang up. Time is better spent hunting for the best deals yourself than expecting good deals from strangers.
Saturday, March 6, 2010
When unsure, don't buy the cheapest
I am a cheapskate. I like to buy things on the cheap. However, this can be a dangerous practice if you do not know what you are doing, especially when it comes to insurance.
The risk of buying the cheapest insurance comes when you try to make claims but cannot because of certain clauses in the contract which the agent conveniently miss out to warn you. The cheaper the contract, the more exclusion clauses it includes and the more stringent are the conditions in which you can make claims. You do not want to buy an umbrella that cannot open when it starts to rain. In matters of life and death for your wallet, the consequences will be disastrous.
I have a general rule when it comes to buying things of vital importance to me. If you are not familiar with the merchandise but still insist on buying it because it is important to you, don't buy cheap. On the other hand, if you are familiar with the merchandise and able to gauge its quality on examination, go ahead to buy on the cheap.
The risk of buying the cheapest insurance comes when you try to make claims but cannot because of certain clauses in the contract which the agent conveniently miss out to warn you. The cheaper the contract, the more exclusion clauses it includes and the more stringent are the conditions in which you can make claims. You do not want to buy an umbrella that cannot open when it starts to rain. In matters of life and death for your wallet, the consequences will be disastrous.
I have a general rule when it comes to buying things of vital importance to me. If you are not familiar with the merchandise but still insist on buying it because it is important to you, don't buy cheap. On the other hand, if you are familiar with the merchandise and able to gauge its quality on examination, go ahead to buy on the cheap.
Thursday, March 4, 2010
Retirement nest-egg before children's college fees
It has been my experience that couples with kids will be aggressively sold financial products designed to help them pay for their children's education and college fees. My natural inclination as a parent is to buy these plans for my children out of love.
On second thoughts, I rejected these plans.
Firstly, I had to weigh my own retirement needs over my children's education fees. In developed countries, it is unlikely the child will lose the opportunity to get a degree because the parents cannot pay for it. There are many options in America that are cheaper for these children nowadays like taking college courses online or attending a community college. But if they want to go through a four-year university course, being young with decades ahead, he is a low-risk borrower to the bank. The bank will loan him money with little hesitation. I can be assured that there will be no lack of help from financial institutions to finance my kid's education.
However, what if I end up with little savings after sacrificing my retirement nest-egg to pay for my kids' education? No bank is going to help me. No bank is going to loan money to retirees with no income and no hope of paying back.
The reasoning is clear. If my children have no money for their education, they get help. If I have no money for my retirement, I get no help. Who should I help first? Myself, of course. I must build up a sufficiently large retirement nest egg before money is allocated for the children's education fees. Take note that once you pay for the first child's education, you got to do the same for the rest. Otherwise, the other kids will cry UNFAIR and this shall become a bone of contention within the family for decades to come. Therefore, if you want to pay for your children's education, then the money set aside must be enough to pay for ALL of them, not just the lucky first few.
Getting children to borrow to pay for their own education is not a bad idea too. A little debt teaches financial discipline. When totally unburdened, a young kid just starting out work may spend without restrain. He is like a teenage boy who just discovered sex. Some debt will check his spending habits.
On second thoughts, I rejected these plans.
Firstly, I had to weigh my own retirement needs over my children's education fees. In developed countries, it is unlikely the child will lose the opportunity to get a degree because the parents cannot pay for it. There are many options in America that are cheaper for these children nowadays like taking college courses online or attending a community college. But if they want to go through a four-year university course, being young with decades ahead, he is a low-risk borrower to the bank. The bank will loan him money with little hesitation. I can be assured that there will be no lack of help from financial institutions to finance my kid's education.
However, what if I end up with little savings after sacrificing my retirement nest-egg to pay for my kids' education? No bank is going to help me. No bank is going to loan money to retirees with no income and no hope of paying back.
The reasoning is clear. If my children have no money for their education, they get help. If I have no money for my retirement, I get no help. Who should I help first? Myself, of course. I must build up a sufficiently large retirement nest egg before money is allocated for the children's education fees. Take note that once you pay for the first child's education, you got to do the same for the rest. Otherwise, the other kids will cry UNFAIR and this shall become a bone of contention within the family for decades to come. Therefore, if you want to pay for your children's education, then the money set aside must be enough to pay for ALL of them, not just the lucky first few.
Getting children to borrow to pay for their own education is not a bad idea too. A little debt teaches financial discipline. When totally unburdened, a young kid just starting out work may spend without restrain. He is like a teenage boy who just discovered sex. Some debt will check his spending habits.
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