When I tell my friends that I've been investing since I was 18, most of them either think I'm crazy or say something along the lines of "you're going to be rich". I wish the latter was true, but unfortunately, due to some speculative bets that I made earlier in my investing journey, I'm still facing a substantial unrealised loss. Over the long term, I definitely aim to achieve a steady passive income through accumulating stable, dividend paying stocks.
My basis for investing is simple - as someone with time on my side, I'm able to ride out the short term volatility of the financial markets. I invest because I want to beat inflation - the interest earned on bank deposits is lower that the inflation rate - meaning that leaving your money in the bank would reduce its purchasing power over time.
I often like to cite the example of banking stocks in Singapore: For the most part of 2016, when the share prices of DBS, OCBC and UOB were trading below their net asset values, it would have made more sense to buy their shares, instead of leaving your money in the bank! Paying less than the net asset value of a stock means that we are getting its net assets at a discount to what it is worth.
A few months back, I spoke to someone in his late twenties, who mentioned that dividend paying stocks made no sense to him. The reason he gave was:
If I buy SingTel shares, the dividend is only 4.5%. By investing $5,000, I would only get back $225 a year, which is too little.
While he was right that the dividend amounted to $225, it would still be many times higher than the interest earned by leaving the money in the bank. If he reinvests the dividends, at a return of 6% annually including capital gains, his initial investment of $5,000 would grow to $16,000 in twenty years' time.
I believe that the main reason why people fail to see the benefits of compounding is due to the need for instant gratification. People like to see a quick profit being made, thus they prefer short-term strategies such as Forex trading or speculating in penny stocks. While I believe that there are professionals who are able to profit through short-term trading, I think that it is difficult for retail investors like us to replicate their performance. Short-term trading requires one to constantly monitor any market movements, and most retail investors do not have the time to be tracking the market throughout the day.
On hindsight, I would advise beginners to start your investing journey with the STI ETF. An ETF is an Exchange Traded Fund, which aims to replicate the performance of an index. This is a cost effective strategy for those with limited capital. The fund's annualised compounded return from its inception in 2002 is 6.94% as of 31 January 2017. It currently has a dividend yield of 3.05%. Take note that the fund has its limitations, as DBS, OCBC, UOB and SingTel collectively represents around 40% of the index, meaning that its performance is largely dependent on the financial sector. However, I believe that it is still the best option for diversification for those with limited capital.
We should begin to invest as soon as possible, and for those with time on our side, compound our returns over the long run, rather than leaving any extra cash in the bank.