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Investing tricks of the wealthy

Average investors can apply the same techniques to their own investments, no matter the size of their portfolio

Dec 19, 2007
By BEN FOK

RECENTLY, I asked a wealth manager whether an average investor can make more money by mimicking the investment strategies of the rich. He answered: not really. Later he explained that the rich invest differently because, well, they're different. They can take more risks because they have more money to lose. Furthermore, they can speculate and have a short-term view because losing money is not a problem for them.

Well, I do not totally agree with his opinion. For the past few years, I have been advising wealthy people on their financial well-being. As a financial adviser, my job is to help these rich clients search for financial services who meet their needs. Throughout my interaction with them, I have gained an insight into how they accumulate wealth.

I can tell that the rich don't necessarily have any special insights into which stocks or assets are going to soar. But what they do have is the confidence to apply a disciplined and systematic approach to managing their money. They have the habit of applying common sense to each investment opportunity facing them. Even though the interests of wealthy investors are not always necessarily aligned with those of the average investor, there are a number of principles and strategies employed by wealthy investors that do apply to virtually anyone who seeks to invest for the future.

It is a common fact that most financial textbooks teach us that in order to build wealth we need diversification, wealth preservation and strategic growth. To me, this not an accurate statement in itself because two of those strategies - diversification and preservation - don't help to build wealth. Perhaps the rich use these two strategies to maintain wealth.

After they have accumulated great wealth, they didn't use the strategies during the accumulation phase and they tend to preserve the wealth they have built. Yet average investors have not yet reached the ranks of the financially independent, so they are generally more concerned about investment growth and losses. The wealthy, as a general rule, do not have this concern. At the same time, they also learn how to avoid taxes legally so that they can keep their money working for them and learn how to pass their assets on to the future generations without the government taking a huge part of what they spent their lives building.

Another common perception is that the rich take more risk, therefore they accumulate wealth faster. However, the truth is that the majority of rich people do not build their fortunes by speculating on high-risk investments as is commonly believed. My experience tells me that the rich do not heavily rely on high-risk investment vehicles like hedge funds or venture capital funds but are moderate risk takers who put more than half of their money into listed securities and keep a large amount as cash. The reason for this is that they have so much money that even if they do not meet their goals for investment growth, it would not be bad news to them; however losing their financial independence would be devastating.

So how do the rich invest? Unlike the average investor, the rich think long term in most of their investment strategies. They believe that there is power in long-term thinking and many of them make it habit of doing so. Great investors like Warren Buffett - his successes in investment include Washington Post Co, where Berkshire invested US$11 million in 1973 and which investment was worth US$1.3 billion at the end of 2006. That is 33 years of holding power which demonstrates his investment philosophy - always invest for the long term. Hence, most rich do not engage in short-term speculation but have a long-term goal in mind.

However, the rich make use of risk by taking advantage of risk. They often build fortunes using volatile assets and investments but that does not mean they were engaging in risky behaviour. They understand the risk and embrace risk because they know it always brings an opportunity for growth; however, the average investor is fearful of risk. Nevertheless, taking risk for the rich does not mean taking a shot in the dark. The rich take calculated risk that means to gain knowledge first and to consider the consequences of failing before taking action. The rich overcome fear with knowledge as knowledge can cause fear to fade away.

The rich also demand value for their money. Otherwise, how do you think they got to be rich in the first place? Value to them is buying assets at a discount to its intrinsic value. So for them the right time to buy is when there is weakness in the market. They buy when others are despondently selling and sell when others are greedily buying. This requires the greatest fortitude but also has the greatest rewards. This bargain-hunting approach to buying value will enable them to buy quality assets at reasonable prices. So they buy when there is bad news and sell on good news. For instance, some of the wealthy invest because they understand that the weakness is only temporary, and the stock price had fully priced in negative news and it was time for them to hunt for bargains again.

If we look back at the Singapore stock market, there are many opportunities for investors to bargain hunt and buy on bad news, e.g. the Asian financial crisis in 1997/98, the Sept 11 terrorist attack and SARS. The rich take advantage of these negative events to buy assets, whether in real estate or stocks and that's where value can be found. However, the average investor will seek to sell and get out of a bear market fearing that the asset will fall in value.

To the rich, probably now is the best time to sell and get out of the market, where all assets prices have gone up in value. Over the past years, we have very good reports about our economic growth and all the good news are now factored into the stock price, so for the rich it's time to sell.

Another investing secret of the rich is that they approach investing like a business. They set up a business plan, establish annual targets, then analyse the results and they have reasonable expectation. At the end of the day what they want to achieve is increasing their net worth and not their income. The rich truly understand the meaning of working smart not working hard: to focus on growing your net worth is working smart but working for an income is working hard. As their net worth grows, they do not increase their spending, instead they increase their investment. By repeating this over the years, once their net worth is built to a certain level, they are free to do what they want. Hence, to increase your net worth you need patience, knowledge, and wisdom.

Often they are not willing to pay more for investment services simply because they find a particular adviser to be charming or knowledgeable. Nor do they chase after the hottest manager or the most publicised fund. Instead, they go shopping for the best combination of reasonable fees and consistently good performance. However, they will pay for advice from people who have specialised knowledge in a field they need to learn about. They don't believe in free advice as it can often be the most expensive advice.

As you can see, most investing secrets of the rich are nothing more than a combination of basic common sense and knowledge. The difference between the rich and the average investor is that they have the self-confidence to stick to the basics and to find out what they need to know. They don't get caught up in the theory of the week or the trend of the month. It's an approach that's easy to articulate but difficult to follow.

However, average investors can learn important lessons from the wealthy, specifically the need to manage both risk and their own investment expectations. The failure to match expectations to the risk an investor is willing to take can result in frequent switching among investments, or even worse. Now the good news for the average investor is that you can apply many of the same techniques to your own investments, no matter how big or small your portfolio is.

Fed proposes mortgage rules to protect borrowers

Dec 19, 2007 - Lenders would have to confirm that a borrower can afford a mortgage before making the loan under protections proposed by the Federal Reserve on Tuesday following the havoc wrought by the US sub-prime loan crisis.

The proposals are intended to replace loose standards that have put many Americans at risk of losing their homes because they took out loans they could not afford and may not have fully understood.

The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans. Millions of Americans who stretched to buy homes in recent years face the risk of foreclosure as mortgages with initial 'starter' rates reset sharply higher.

The Fed's board of governors unanimously approved the standards recommeded by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.

'These new rules, once adopted, would apply to all mortgage lenders,' Fed Chairman Ben Bernanke said as the board met to consider the proposal. He said the rules would be 'consistently applied and vigorously enforced' by state and federal regulators.

The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.

The proposal was criticised by several leading lawmakers and praised by an industry group.

The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts and other documentation. That is aimed at ending the recent practice of so-called 'stated income' loans in which borrowers could state a particular income without anything to back the claim up.

The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No 'prepayment penalty' would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.

The proposed rules also would require that borrowers receive details on their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.

The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.

The proposed regulations protect borrowers with interest rates of more than 3 percentage points above Treasury securities of similar duration. For example, a 30-year Treasury bond yields around 4.55 percent, and so a 'high-cost' 30-year mortgage loan today would have an interest rate of 7.55 per cent or higher.

Several leading lawmakers said the new rules were too little, too late and suggested Congress should assume some of the Fed's consumer protection role.

Senate Banking Committee Chairman Christopher Dodd faulted the Fed for limiting mandatory escrow to the mortgage's first year and opening only a two-month window of prepayment protection.

'It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions,' the Connecticut Democrat said.

Mr Dodd, a Democratic presidential hopeful who has sponsored legislation aimed at reforming sub-prime mortgage lending, said legislative action was needed to help protect homeowners from 'abusive and predatory lending practices'. The Senate has yet to act on his legislation, but the House of Representatives has passed a bill aimed at curbing predatory lending practices.

The American Bankers Association praised the Fed for setting standards that could reach mortgage lenders who used Wall Street money to dive into the market and generally loosened standards more than depositor-backed institutions.

The proposed regulations will be open to public comment for 90 days before the Fed staff proposes final rules. At that point, there will be another public comment period, pushing final adoption well into next year.

HK's central bank cuts base rate by 25 basis points

Dec 12, 2007 - The Hong Kong Monetary Authority (HKMA) on Wednesday lowered the base rate charged through its overnight discount window by 25 basis points to 5.75 per cent.

The HKMA's move came after the U.S. Federal Reserve cut benchmark interest rates by a quarter-percentage point to 4.25 per cent to prevent economic fallout from credit turmoil stemming from troubles in the U.S. mortgage market.

Hong Kong tends to track US rate moves because its currency is pegged to the US dollar.

The HKMA, Hong Kong's central bank, sets its base rate through a formula that includes the US federal funds rate and Hong Kong interbank offered rates.

Fed Lowers Rate by a Quarter Point to 4.25 Percent

Dec. 11 (Bloomberg) -- The Federal Reserve lowered its benchmark interest rate by a quarter point to 4.25 percent, while signaling officials are open to further cuts if the housing slump and credit squeeze worsen.

Stocks fell and Treasury notes surged after the decision, which some economists said fell short of what's needed to spur lending and avert a recession. The central bank also pared the discount rate by a quarter point to 4.75 percent, counter to speculation among investors that the Fed would make a deeper reduction.

``Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,'' the Federal Open Market Committee said in a statement after meeting today in Washington. Lower borrowing costs ```should help promote moderate growth over time.''

The Fed dropped language from its previous statement that risks of slower growth and faster inflation were ``roughly'' balanced. The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers.

Policy makers are actively considering steps to ease credit in financial markets, and haven't ruled out moves to increase liquidity before their next scheduled meeting on Jan. 29-30.

``If things deteriorate they will cut again,'' said Stephen Cecchetti, professor of international economics at Brandeis University in Waltham, Massachusetts, and a former director of research at the New York Fed. ``If financial conditions don't start to improve dramatically,'' officials might have to cut before their January gathering, he said.

Discount Rate

The gap between the discount rate, which the Fed charges for direct loans, and the federal funds rate, the rate banks charge each other for overnight loans, remains half a point.

``Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending,'' the FOMC said. ``The committee will continue to assess the effects of financial and other developments in economic prospects and will act as needed to foster price stability and sustainable economic growth.''

The central bank also said some ``inflation risks remain,'' and probably was reluctant to reduce borrowing costs at all, said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute in Washington.

Rosengren Rebels

Today's decision, which matches the median forecast of economists surveyed by Bloomberg News, wasn't unanimous. Boston Fed President Eric Rosengren voted in favor of a half point cut.

Rosengren has a background in banking, having formerly headed the Boston Fed's banking supervision department. His research focused on financial crises including New England's credit crunch in the early 1990s and Japan's bad-loan debacle last decade.

The Dow Jones Industrial Average slumped 2.1 percent to 13,432.77, while the yield on the two-year Treasury note -- among securities most sensitive to official interest rates -- fell about a quarter-percentage point to 2.92 percent at the close in New York.

``When stocks go into a tailspin after you release your press statement, you know as a central banker that you didn't meet the market's expectations,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``There were rumors today about the possibility of 50 basis points, so that was a modest disappointment.''

Policy Under Bernanke

The benchmark rate is now at the lowest level since January 2006. Ben S. Bernanke, 53, who succeeded Alan Greenspan as chairman the following month, continued a series of increases that lifted the federal funds rate to 5.25 percent by June last year.

Policy makers held their ground until August this year, when the collapse in assets backed by subprime mortgages roiled markets around the world and forced central banks to pump billions of dollars into the banking system. It also spurred the Fed to start cutting the federal funds rate in September. The Fed was joined last week by the Bank of Canada and Bank of England.

Investors became confident of further reductions after Bernanke and Vice Chairman Donald Kohn said in separate speeches last month that ``turbulence'' in markets could alter their outlook for growth. Fed officials estimated in October the economy would grow 1.8 percent to 2.5 percent in 2008. Rosengren said Dec. 3 that the expansion will be ``well below'' its long- term pace for the next two quarters.

Weaker Numbers

Since Fed officials made their forecasts, government reports show orders for U.S.-made durable goods fell in October, capacity-use rates in the nation's factories slipped and retail sales slowed. Payrolls increased by 94,000 jobs last month, after a 170,000 increase in October.

The economy will expand at an annual pace of 1 percent in the fourth quarter, down from 4.9 percent in the previous three months, according to the median estimate in a Bloomberg News survey of 63 economists.

The number of Americans who fell behind on their mortgage payments rose to a seasonally adjusted 5.6 percent in the third quarter, the highest in two decades, the Mortgage Bankers Association said last week. New foreclosures hit a record.

As creditors took possession of properties, the supply of unsold homes grew to a 10.8-month supply in October. Prices of previously owned homes fell 5.1 percent from a year ago, the most on record, according to the National Association of Realtors.

Across Atlantic

The credit deterioration has spread to Wall Street and commercial banks around the world that hold bonds and derivative contracts created from pools of home loans. Banks including Credit Suisse Group in Zurich and London-based Barclays Plc are among lenders that have marked down more than $50 billion on losses linked to U.S. home loans.

Because banks are protecting capital, lending has been cut and concerns about counter-party risk are higher. About 40 percent of lenders have increased their standards for the most creditworthy borrowers to qualify for a so-called prime loan, according to a Fed study in October.

Throughout the rate cutting-cycle, Fed officials have highlighted longer-term inflation risks in their statements and their public remarks. Oil prices hit a record $99.29 a barrel in New York on Nov. 21, and traded at $89.21 this morning.

The Fed's preferred gauge, the personal consumption expenditures price index excluding food and energy, rose 1.9 percent in October from a year ago. The index has remained below 2 percent since June.

Not all bonus issues are good news

BONUS share issues are usually viewed positively. Investors welcome them and companies always present such issues as efforts to reward shareholders. And there have been no shortage of bonus issues on the Singapore Exchange (SGX) in recent months. At least a dozen or so SGX-listed companies have announced bonus issues, according to filings with the stock exchange.

However, like most things, bonus issues aren't always all that they are made out to be.

A bonus issue refers to the issue of new shares to existing shareholders at no cost and in direct proportion to their existing shareholdings in the company. So in a 1-for-4 bonus issue, for instance, shareholders get one new share for every four existing shares they hold.

Because bonus issues are free, it is well understood that they do not directly benefit the company. This is unlike rights issues (where shareholders pay for rights shares at a discount to the market price) which raise funds for the company. Bonus issues also do not materially alter the balance sheet of a company. They are normally done using the retained earnings of a company and involve a book entry transferring an amount from retained profits to share capital. This is also known as the capitalisation of reserves.

But do bonus issues really benefit shareholders, as companies make them out to be?

This is debatable. It can be argued that, theoretically, a bonus issue brings no additional benefit to the shareholder.

While it is true that the shareholder would end up with more shares at no cost, the share price would - theoretically at least - also adjust downwards accordingly to what the market calls the theoretical ex-price. Issuing bonus shares also has the effect of diluting earnings per share.

One way shareholders would benefit from a bonus issue is when the adjusted lower share price makes the stock more affordable and encourages more investors to invest in it. This would result in more liquidity and potentially more upside for the share price.

This would be what companies want shareholders to believe, and indeed, is the rationale given in every bonus issue announcement. Such an outcome is not a given, however, and the share price performance depends not just on having more shares in issue but on a host of other factors.

There are, in fact, some hidden dangers in bonus issues.

For one, companies may be making bonus issues in lieu of dividends. So while getting more shares at no cost, shareholders may be forgoing cash dividends. In some cases, like when a company needs to conserve cash to expand its business, there are sound reasons for a bonus issue in lieu of dividends. But this does not apply to all situations, and shareholders should ask if a bonus issue is masking the lack of dividends when these should be forthcoming.

Another danger is when a penny stock makes a bonus issue. While there may be a good reason for a high-priced stock to make a bonus issue to improve affordability and boost liquidity, it's harder to apply this logic to penny stocks which are already affordable in the first place. So if a penny stock becomes even cheaper, it may pull in speculators rather than long-term investors. Indeed, institutional shareholders - which companies value - are known to shun very low-priced stocks. Attracting speculators and the syndicates may boost the share price in the short term, but if this comes at the expense of having serious investors as stakeholders, it could ultimately curb the upside potential of a stock in the long term.

The other thing to watch out for is when recently listed companies make bonus issues. Companies often say they are rewarding shareholders' loyalty when they make a bonus issue. For a newly listed company, however, there really is no shareholders' loyalty to speak of. So the motives a company has in making a bonus issue in such a situation should be questioned.

Of course, there are many bond fide bonus issues made by companies which are doing well, are confident of their future prospects and are genuinely seeking to reward shareholders. But investors should not see all bonus issues as good news. There may well be a sting at the end of the tail.

Weekly Indicators - Nov 1

Nov 1st 2007
From The Economist print edition

The Federal Reserve cut its target for the federal funds rate to 4.5%. One member of the Fed's rate-setting committee voted to keep rates unchanged at 4.75%.

Other central banks followed a different path. Sweden's Riksbank raised its benchmark interest rate by 0.25 percentage points to 4% and said further increases were likely. India's central bank left rates unchanged but raised the cash reserves that banks need to keep with it from 7% to 7.5% of total lending. Central banks in Japan, Norway, Hungary, Poland and Malaysia all kept their key interest rates unchanged.

America's GDP rose at an annualised rate of 3.9% in the third quarter, according to an initial estimate. The stronger-than-expected increase owed much to an improved trade performance, which almost offset the adverse effects on growth of falling housebuilding. The S&P/Case-Shiller house-price index that covers 20 large American cities fell by 4.4% in the year to August.

Consumer prices in Japan fell by 0.2% in the year to September. Prices excluding fresh food fell by 0.1% from a year earlier. The unemployment rate rose from 3.8% to 4%.

Consumer prices in the euro area rose by 2.6% in the year to October, according to a preliminary estimate, compared with 2.1% in the year to August. The unemployment rate fell to 7.3%. The figure for August was revised from 6.9% to 7.4%, owing to changes to the way Germany's jobless are counted.