What Are Stocks And ETFs? We Break It Down For You.

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Investments can often seem daunting, and you may not be sure how and where to start. In our latest series, we break down the different types of investments available in Singapore and guide you through the various steps to investing. 

When one thinks of investing, the first thing that comes to mind is probably the stock market. Yet for first-time investors, choosing the right stock to purchase can be an intimidating decision. To add to the confusion, there is no lack of investment strategies and theories that all seem to be offering diametrically opposite advice.

For those who prefer not to spend their precious time poring over financial statements and fretting over fluctuations in share prices, Exchange-Traded Funds (ETF) might just be the solution, specifically ETFs which track Singapore stock exchange’s key indicator, the Straits Times Index (STI). In the long-term, these funds are fairly low-risk yet reap significant returns.

How Stocks And ETFs Work

Suppose you have a friend who wants to fulfil her lifelong dream of opening an artisanal bubble tea shop in downtown Singapore. Except that she is broke, and so she comes to you to borrow some money as capital. You shell out $50,000 and in return, instead of having her sign a loan agreement, you request a 50% stake in her business.

Quite a while later, her business is flourishing and is making a profit. A portion of this profit she distributes back to you while the rest is used to open new branches, thereby making the business much more valuable. At this point, someone offers you $500,000 in exchange for your 50% stake in the bubble tea business but you refuse, for you believe that its value would further increase.

Unfortunately, in the following year bubble tea falls out of fashion. The business is making a loss and one by one each outlet is shuttered. Eventually, your friend is forced to sell the business and after paying off all the creditors she presents to you what is left of your stake: a paltry $50. You wish you had never invested in your friend’s business in the first place.

In essence, this is a picture of how stocks work.

You purchase shares of corporations listed on Singapore’s stock exchange (SGX). Each share represents a stake in the company. Given that the total number of shares issued by a corporation is in the millions or perhaps billions, each share is probably equivalent to the owning something like 0.0000000000000001% of the corporation.

There are two primary ways of obtaining returns on your investment. The first is through cash dividends, where companies distribute a portion of its profits to its shareholders. This typically takes place once or twice a year, or even quarterly. The rest of the profits are reinvested back into the company for its future growth. 

As the company grows, its share price is also likely to increase. You would be able to earn a profit if you now decide to sell your shares on the stock exchange. This is known as capital appreciation and is the second way of obtaining returns.

But what if the company doesn’t perform well. Or worst, goes bust? Its share price would plunge and all that you own could be reduced to nothing. A good case in point would be Sembcorp Marine, a major public company. From a high of more than $4 per share in 2011, its share price is now hovering pathetically over $1.

Diversification: From Stocks To ETF

The common-sense way to alleviate this risk is to purchase shares from various companies and industries. In other words, don’t put all your eggs in one basket. This is popularly termed diversification, and is a sensible approach to risk management. The problem is not everyone has sufficient capital to invest in that many stocks as shares are sold in lots of one hundred; each lot is likely to cost hundreds or thousands of dollars.

That is where ETFs come in. As its name suggests, they are funds that are traded like normal shares on SGX, except that instead of purchasing a share in a company, you are purchasing a share in a fund. The fund is made up of a basket of stocks, and so owning a share in the fund is equivalent to owning a share in all the underlying stocks the fund comprises.

Why Buy The STI ETF

The Straits Times Index (STI) is a weighted index that tracks the performance of the top 30 stocks listed on SGX. It is therefore deemed as a measure of the local stock market’s performance, and by extension that of Singapore’s economy. 

ETFs that track the STI are invested in the same top 30 stocks in proportion to their weightings within the STI. This means that by purchasing a share in a STI ETF, you are automatically investing in all the top 30 companies of Singapore’s stock market. This is a much simpler approach as compared to separately purchasing shares from each of the 30 companies. 

Historically, Singapore’s stock market has shown an upward trend in the long-term. Since the ETF’s performance is directly correlated to the STI, based on past record it is likely that it would appreciate in the long-term. Long-term, however, might mean decades, and so the STI ETF won’t be suitable for those who want to earn a quick buck. 

The expense ratio (percentage of the fund’s assets that is used to cover administrative and other operating expenses) of the STI ETF is also relatively low in contrast to other investment funds. The implication? Less of the fund enters the pockets of the fund’s managers, and more goes to you.

How To Buy The STI ETF

There are two ETFs that track the STI that you may choose from: SPDR STI ETF (ES3) or Nikko AM Singapore STI ETF (G3B). Much comparison has been drawn between the two to determine which is better, based on factors such as the fund’s track record, its size, expense ratio, etc. These considerations appear to indicate that SPDR has a slight edge over Nikko.

To purchase either of the ETFs, you would need to open an online trading account with a brokerage firm since, as mentioned earlier, ETFs are traded on SGX.

Popular brokerage firms include DBS, OCBC, Philips Securities and Standard Chartered. The key consideration in choosing a brokerage firm is how much commission it charges for each trade. Currently, Standard Chartered appears to be the most attractive option due to its low commission rate and minimum fee.

Regular Savings Plan

Alternatively, you may choose to register enrol in a Regular Savings Plan, which is offered by banks such as POSB and OCBC. A fixed sum of money, from as low as $100, is automatically deducted from your bank account every month to be invested in either of the two STI ETFs.

The advantage is the low minimum commission fees, which makes sense for those who wish to set aside a small fraction of their monthly salary for investment.

This is the second article in a series of articles on investing for first-time investors. Read our first part here.