1. GEK2507 1 Frederick H. Willeboordse frederik@chaos.nus.edu.sg Compound & Prosper!

2. GEK2507 2 Accumulating Assets Lecture 11

3. GEK2507 3 Mutual Funds, Index Funds and ETFs Buy or Rent? Making the million … is easy! Or is it??? Compound …. Basically, there are two simple ways to accumulate wealth that are practical for most of us. Real Estate and Stocks. Let us have a look at both of them before jumping to the last item. Buy: 700,000 Rent: 2,000 Today’s Lecture

4. GEK2507 4 There are roughly 5 ways to invest in stocks: Buy and select stocks yourself Buy stocks on advice of an advisor/personal banker Buy a mutual fund (unit trust) Buy an index fund Buy Exchange Traded Funds (ETF) Note: All the comments are based on the assumption that we are average investors at best… Investing in Stocks

5. GEK2507 5 Buy and select stocks yourself Nowadays with cheap internet broking readily available, selecting and buying stocks is very easy (especially in countries like the US where you can buy single shares). However, this is a risky venture! It is very difficult for an individual to beat the market (and in fact most of the professionals as well). Investing in Stocks

6. GEK2507 6 Buy stocks on advice of an advisor/personal banker Unless one has very large sums to invest, it is rather unlikely to be assigned a sufficiently qualified personal banker. Personal banking is very expensive …. and hence not very suitable for the average investor. Investing in Stocks

7. GEK2507 7 Buy a mutual fund (unit trust) In a mutual fund or unit trust, the money of thousands of individuals is pooled and then invested by the fund manager according to the nature of the fund. Since ‘shares’ only indicate how much is contributed to the pool, it is not necessary to buy entire shares and one can buy e.g. 0.1234 shares. In fact, usually one would buy for a round sum e.g. $100 rather than a certain number of shares. Mutual Funds are pretty good, but!, there are significant costs. Investing in Stocks

8. GEK2507 8 Buy an index fund Index funds are a special type of Mutual fund that exactly track an index. Therefore, their performance will almost exactly be that of the market. A good way to invest with a hands-off approach. The costs are generally low and risks can be much lower as well in the case of broad-based indices. Well, the marketing as always moves me to tears.. Investing in Stocks

9. GEK2507 9 Buy Exchange Traded Funds (ETF) Exchange Traded Funds are shares listed on the stock market that (almost) exactly track an index. Since they are actual shares, they can be bought and sold any time but only as entire shares. Pro: Basically all the advantages of Index Funds but easy to trade. Con: For small amounts of money, however, the trading costs may not be worth it. A famous ETF is the so-called Spider which tracks the US SP500 index. ETF Investing in Stocks

10. GEK2507 10 Mutual Funds vs Index Funds: Investing is a zero sum game as with regards to the overall market performance. If one investor outperforms the market another will underperform it by definition. The big problem with Mutual Funds is their costs. E.g. most mutual funds in Singapore have a 5% upfront charge plus a 1.5% annual fee. Index Funds (in the US) usually only charge about 0.27% Investing in Stocks

11. GEK2507 11 Mutual Funds vs Index Funds: Let us see what this means for 20 years IF the mutual funds perform as well as the market. =E7*(1+$F$4)*(1-$F$2)+$D8*(1-$D$2) =F7*(1+$F$4)*(1-$F$3)+$D8 Investments made at end of year. A difference of nearly 12,000 dollars! Or more than 22%!!! Investing in Stocks

12. GEK2507 12 Mutual Funds vs Index Funds: Ergo: If the Mutual Funds performs as well as the index, the index funds will do better by more than 22% in this example. However, on average, Mutual Funds actually underperform the index!!! Hence, on average, the difference is even bigger! Percentage of Stock Funds Outperformed by Index (Last 10 years, US, Funds investing in large companies) Investment StyleValueBlendGrowth Percentage76%91%86% Ouchhhh! Investing in Stocks

13. GEK2507 13 Mutual Funds vs Index Funds: In conclusion, historically speaking, the simplest and safest way to invest in stocks is through sufficiently broad based index funds (or for that matter exchange traded funds). Percentage of Stock Funds Outperformed by Index (Last 10 years, US, Funds investing in large companies) Investment StyleValueBlendGrowth Percentage76%91%86% This hurts. Investing in Stocks

14. GEK2507 14 We all would like to own our own home and there’s of course nothing wrong with that. The question being: “Is this the best way to make money?” Surely paying rent can’t help to make me rich. If I buy a flat, the mortgage is for my own property. It’s like paying to myself. And, appreciation of the flat is on the full value not just on the part I’ve already paid for. Or is it? Excel to the rescue! Buy or Rent?

15. GEK2507 15 This looks like quite a complex problem, hence, as always, let’s take it step by step and start with a list of things we need to take into account. Rent as a percentage of the Price of the Flat/House Mortgage Rate Appreciation of Flat/House Return on alternative investment (e.g. Stocks) Do we need the price of the Flat/House? Do we need inflation? Buy or Rent?

16. GEK2507 16 =PMT($F$4,$I$4,-$I$3,0) =F11*$F$3 =F11*$F$5 =E12-D12+G11* (1+$F$6) Yearly basis! Buy. These are fairly reasonable percentages. Value of Investment Account if difference between Mortgage and Rent is saved. Buy or Rent?

17. GEK2507 17 Don’t Buy. All we did is change the appreciation from 6% to 4%. Buy or Rent?

18. GEK2507 18 Buy ???Buy All we did is change the appreciation from 6% to 5%. ? Buy or Rent?

19. GEK2507 19 Buy !!!!Buy All we did is change the appreciation from 6% to 8%. Buy or Rent?

20. GEK2507 20 So should we buy or rent? You decide! I’d say, probably yes unless we either expect appreciation to be very low or stock market gains to be very high. Both not very likely in the long run in an advanced economy. In any case, whether to buy or rent depends on many factors and is in that sense a very complex decision. Buy or Rent?

21. GEK2507 21 By now, you might have guessed it. The ‘secret’ to becoming a millionaire is both, a silly AND a serious matter. It’s all about compounding! The silly part: A million in 45 years is worth less than a million today. The serious part: It can actually be done even when compensating for inflation. Finale

22. GEK2507 22 First, let’s see how much a million is actually worth in 45 years: =PV(0.035,45,0,-1000000) Still, 212,659 dollars is not bad at all! But I want a real million: Finale

23. GEK2507 23 How many dollars do we need in 45 years to have the same as 1 million dollars now? =FV(0.035,45,0,-1000000) We’ll need 4,702,359 million. IMPOSSIBLE!!!! (Same formula with P->F) Finale

24. GEK2507 24 A letter to Bill Gates! Dear Bill, I would like to be a millionaire. Could you kindly please transfer $1,000,000 into my account as soon as possible. Thank you, Frederick P.S. Microsoft makes my favorite software. Honestly! Finale

25. GEK2507 25 And he could reply Dear Frederick, If you like my software, try using Excel and think of compounding. Yours, Bill P.S. Microsoft makes my favorite software too! A Better Idea!

26. GEK2507 26 Sigh! Ok let’s try … We’ll need 4,702,359 million…. That’s not so bad! Finale

27. GEK2507 27 Getting close … We’d have more than 4,702,359 million….if only … Wow, but it would be nice if we could push this below 200 dollars. Finale

28. GEK2507 28 Wait a moment! 200 dollars now is a lot more than 200 dollars in 45 years! We should take that into account. Let’s increase the monthly amount gradually. There you go! ~ Avg. return SP500 last 60 years Inflation plus 1.5% Becoming a Millionaire Possible, right!

29. GEK2507 29 Conclusion: By saving only a small amount every month, it is indeed possible to become a millionaire! With patience of course…. Probably … Becoming a Millionaire

30. GEK2507 30 History could be wrong! True but it’s the best we have, plus even if the average rate will turn out to be less, the power of compounding is still there. In any case it’s going to be a lot of money. Pitfall

31. GEK2507 31 Now: Open an account with a reliable online broker and regularly invest small amounts in Spiders or a similar product until you retire. In a little while: Buy a Flat Don’t put all your eggs in one basket. With your base money, do this: If you have extra money to save, do this: Enjoy yourself! Though saving a bit extra can’t hurt of course…. Think for yourself! Disclaimer: I’m not taking any responsibility for this! My Thoughts

32. GEK2507 32 Compound Long and Prosper ! All the best and good luck! Key Point of the Course