You may have heard how Warren Buffet had won a 1 million by betting in an S&P 500 index fund against a portfolio of hand-picked hedge funds.
If you haven’t, here is the summary in one line: Warren Buffett waged a bet that an S&P index fund could beat a hand picked portfolio of hedge funds over a period of ten years. He won the bet.
The bet started on 1 Jan 2008 and ended on 31 Dec 2017.
At the end of the ten-year bet, the S&P 500 index fund returned 125.8% while the hedge funds returned an average of 36.3%.
Keeping Costs Low is one crucial factor
In his 2016 BRK letter, Warren Buffett explained that the keeping costs low is the crucial factor for most average investors.
The standard ‘2 and 20’ hedge funds fee is expensive. It means 2% annual fees, whether the fund is doing well or not, and 20% of profits will be paid to the fund managers with no clawback. These, Warren Buffett argued, had made the fund managers rich, leaving investors worse off than investing in a low-cost index fund.
Hedge funds are an extreme example. If we look at actively managed funds, a difference in the fees adds up over the years.
If your actively managed fund costs 2%, it will have to consistently outperform the index more than 2% each year to breakeven with a passively managed fund.
Because it is hard to outperform the market consistently by a margin, statistically speaking, it is better to stick with passive investing.
The Singapore Index – Straits Times Index (STI)
So for Singapore investors, naturally when we think about index investing, we will think about buying an ETF that tracks the Straits Times Index (STI).
There are currently two ETFs:
- SPDR STI ETF (ES3.SI)
- Nikko AM STI ETF (G3B.SI)
Either ETFs are excellent, and that’s it. You are done with index investing.
Right? Not so fast.
What If Warren Buffett Invested in the SPDR STI ETF instead of the Vanguard S&P 500 Admiral Fund?
If, in some alternate universe, Warren Buffett decides to invest in a passively managed STI ETF in his 1 million dollar bet, would he have won easily?
Taking the numbers from the yahoo finance, and comparing the final numbers as listed in the BRK 2017 Letter, the SPDR STI ETF narrowly loses the bet.
The S&P 500 index fund completely outperforms everyone. The hedge funds outperformed the STI ETF.
Diversification
The Strait Times Index contains a diversified basket of 30 stocks. However, it is limited to stocks within Singapore.
When you buy the STI ETF, you are actively choosing the Singapore market (which is <1% of the world’s market capitalization) over all other countries in the world.
It is an active decision on your part. In a sense, it is active investing.
Concentrate on the best-performing country in the world?
Warren Buffett may have a bit of luck on his side (or maybe he knew it all along). The S&P 500 had the best returns in the world over those ten years after the 2008 financial crisis.
What if Warren Buffett decided to use a low-cost global world index fund instead?
The MSCI ACWI index includes developed and emerging markets, while the MSCI World index includes developed countries. Both of them performed better than the STI ETF but still underperformed the S&P 500 index fund.
The MSCI ACWI and MSCI world had also beaten the hedge funds but with a smaller margin compared to the S&P 500.
So, if you bought an index fund of the best-performing country, you will no doubt beat a globally diversified index fund.
If you bought an index fund of a lower-performing country, you would have done worse than a globally diversified index fund.
So, Should We Only Choose The Best Country and Double Down?
The main challenge with selecting the best-performing country is that you can never predict which country will do better.
Even if you had invested in the best-performing country right now, you might never whether it will continue to outperform.
Japan, during the early 80s, was the largest market cap and had the best returns. However, if you had invested in Japan in 1989, you will not have recovered your investment even until today – it never recovered from its peak.
Hence, it is difficult to choose the best performing country.
The more sensible and easier way is to diversify globally and avoid getting the worst returns.
A global portfolio is less riskier.
Which Funds Could We Invest In Singapore?
Most of the passively managed index funds or ETFs are low cost 0.09 – 0.30%.
The US stocks make up most of the globally diversified indices, e.g. 60% of MSCI World. For non-US investors, we have an additional cost incurred – foreign withholding taxes. Currently, the tax amount is 30% of your dividends paid.
To further reduce costs, we should look for Irish domiciled UCITs funds – the foreign withholding taxes are lesser, i.e. 15%.
ETFs that track the MSCI World Index (developed markets)
| ETF | Ticker | Listed | Total Expense Ratio |
|---|---|---|---|
| iShares Core MSCI World UCITS ETF | IWDA | LSE | 0.20% |
| SPDR MSCI World UCITS ETF | SWRD | LSE | 0.12% |
ETFs that track FTSE All-World Index and MSCI ACWI (Both developed and emerging markets)
| ETF | Ticker | LIsted | Total Expense Ratio |
|---|---|---|---|
| Vanguard FTSE All-World UCITS ETF | VWRA | LSE | 0.22% |
| SPDR MSCI ACWI UCITS ETF | ACWD | LSE | 0.40% |
All these options require a brokerage that has access to the UK market. Most of them are in USD, which may also incur currency exchange spreads.
If you prefer to use a unit trust, you can purchase a unit trust in Fund Supermart:
| Fund | Total Expense Ratio |
|---|---|
| Infinity Global Stock Index Fund (SGD) | 0.75% |
There are also advantages of holding a domestic index fund as you get to take part with our local economy and not incur foreign exchange risk. That is also the core of the Boglehead three-fund portfolio
If these are too troublesome, you can opt for a roboadvisor that will give you a diversified portfolio. They will make managing the portfolio much easier but it will cost you more.
Staying Invested
The last point is you will need to stay invested. Two things will happen when you move in and out of the market:
- Incur more costs due to more transactions made.
- Lose out on the best days in the market
Each time you buy or sell, you will incur costs that will add up over time.
Also, if you move out of the market, you might miss out on the big rallies. The data from JP Morgan shows that even if you missed the 10 best days, you annualized returns drops significantly.
Hence to help you stay invested, you will need a portfolio that is risk-adjusted to your risk tolerance and needs.
It does not mean that being young, you have to take more risk (although you have the capability of handling more risk). If you try to take more risk and it ends up making you stressed and causes you to exit the market.
Staying invested at all times for an extended period is the hardest part of passive investing. Adjust your portfolio risk accordingly to help you stay invested and stay sane.
Refer to my previous article to get more detailed information.
Key Principles of Passive Investing
There are three fundamental principles in passive investing philosophy:
- Keep costs low
- Diversify
- Patience
We often talk about the power of compounding over long periods – a small investment can grow into a substantial amount over time. The same goes for fees too – a small fee and compound into a large amount over time.
Diversification is essential in managing risk. A passive strategy would require you to hold a basket of diversified assets across different countries or regions. Do not limit yourself to your home country only.
Lastly, passive investing requires a lot more time before you can reap its rewards. It is mainly a buy-and-hold strategy. To help you stay invested, always make sure that create a risk-adjusted portfolio.
Based on these principles, here are samples of a Singapore index investing portfolio:
| Option | Equity | Bond |
|---|---|---|
| 1 (Developed + Emerging Markets ETF) | VWRA.L | A35.L |
| 2 (Developed Markets ETF) | SWRD.L | A35.L |
| 3 (Unit Trusts) | Infinity Global Stock Index(SGD) | Lion Global Short Duration Bond CL A DIS SGD |
Fatty's Finance 