How You Can Be The Best Passive Investor

I was having a conversation with a relative of mine over the weekend. He was tired of investing in mutual funds (also known as unit trusts here) and insurance plans that have a strong investment-linked element to them.

The latter type seemed particularly onerous as my relative would be forced to take a big loss if he terminates those plans before they mature.

Passive investors’ dilemma

Unfortunately, this is the reality for many passive investors. In here, a passive investor refers to someone who prefers to spend less time on his or her investments but would still prefer to have a reasonable return by investing those savings in the financial market.

In the past, there weren’t too many choices for a passive investor so most of them ended up investing with mutual funds or investment-linked insurance plans. Others might end up just plonking their capital in fixed deposits to enjoy the low but practically risk-free return.

Things are different now and there are other outlets for passive investors to invest. But interestingly, such outlets are not well-publicised. I shared them with my relative and I thought I would do the same in here as well.

A different way

The problem with mutual funds is that the distributors that sell the funds tend to get a commission when the investment’s first made. Thus, an investor would already have suffered some loss of his capital before  he has even started investing.

On top of that, mutual funds tend to have higher costs of management (more on this later) and the odds are also stacked against them when it comes to their ability to generate market-beating results.

With these in mind, we can take a look at the advantages that exchange-traded funds (ETFs) like the SPDR STI ETF (SGX: ES3) and the Nikko AM Singapore STI ETF (SGX: G3B) have over mutual funds.

The two ETFs track the fundamentals of Singapore’s market barometer the Straits Times Index (SGX: ^STI) and are bought and sold on the stock market freely like any other share. These give investors the ability to access market-like returns without having to pay for huge commissions or see their funds locked up till certain maturity dates.

Management costs (also known as expenses ratios) for the two ETFs are also lower than most mutual funds or unit trusts in Singapore. For instance, the SPDR STI ETF has an expense ratio of just 0.3% whereas the average expense ratio of stock-based funds in Singapore in 2013 was 1.94%, according to fund-research outfit Morningstar. These seemingly small differences in fees can really make a huge difference to our returns over time, all things being equal.

Foolish Summary

Yet, if you are considering an investment into ETFs, there are still a few important things you have to keep in mind.

As ETFs are easily liquidated, we must not be tempted into trading in and out of ETFs, keeping in mind that frequent trading lowers the odds of us making a profit.

Investors in the ETFs tracking the Straits Times Index must also be contented with getting a market-like return.

Moreover, the stock market is inherently volatile and we should not expect a consistent positive return in each year. There will be years where we’d be sitting on losses and there’d be years where we will gain a huge amount.

The secret to being a great passive investor is in staying passive and have the discipline to invest for the long-term.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.