Hey there! If you’ve started doing some research into FIRE (don’t know what FIRE is? Check out my “What is FIRE?” post before continuing!) you may have run into the concept of the 3-Fund portfolio. Then if you, like me, wanted to setup a similar portfolio here in Singapore, you would have found that most of the resources are focused on people in the U.S. and isn’t very useful for us. That’s why I’ve taken some time to do the research for myself and have compiled the information here in the hopes that it will help you to build a similar portfolio.
So now that’s out of the way, let’s dive into the meat!
Super Short Summary of the 3-Fund Portfolio
The 3-Fund portfolio is one of the core pillars of FIRE. It is a simple and straightforward way to structure your investment portfolio to position yourself for long-term investment success. Explaining the details of why and how the 3-fund portfolio works is outside the scope of this article, you can read up more about it by following this link to the Bogleheads website for more details.
The portfolio, true to its name, consists of 3 parts:
Each of the parts of the portfolio plays a unique role, so let’s dig into how you can set this up for yourself!
Local Stock Market Index Fund
Let’s start with the easy one to get it out of the way.
For those new to the 3-fund portfolio concept, the purpose of the local stock market index fund is to provide you with a portion of your portfolio that is not impacted by foreign currency risk. The local stock market index fund should be denominated by the currency of your monthly expenses (in this case, Singapore Dollars) such that, if SGD drops in value relative to other currencies, you have a pool of investments that you can draw on that has not dropped in value.
Generally when we discuss indexing, we’d want a broad-based index with a large number of companies in them to provide diversification. However in Singapore, the only index is the Straits Times Index (STI) which is made up of only 30 companies, but it is the best we’ve got.
Currently there are only 2 possible choices of ETF that replicates the STI:
Here are some of the important data points for each of these ETFs:
|Net Asset Value (NAV) as of 08-08-18||SGD $662.02 M||SGD $233.17 M|
The SPDR has a slightly lower expense ratio and have roughly 3x the NAV so SPDR is much larger as it has been around much longer. However, they are very similar and it would not matter much which one you choose, so won’t worry too much about this and just select whichever ones that is more convenient or if it matches any plans that your brokerage offers.
Personally, I’ve selected the SPDR Straits Times Index ETF for my portfolio, because my brokerage account is with Philips Capital (using their POEMs platform) and their Regular Savings Plan only offers the SPDR for the monthly shares purchase. I’ve set mine to purchase S$1,000 worth each and every month so I will always be dollar cost averaging into the STI.
If you’re wondering about the past returns of the STI ETF, I’ve written a post on the returns you would have gotten if you Dollar Cost Averaged into the STI ETF in the past 10 years here.
Note as of 4-Apr-2020: Due to the lower expected returns and lower diversification of the STI ETF (relative to international funds), I personally started out targeting just 20% of my portfolio in STI ETF. Just this year I have reduced the allocation to just 10% of my portfolio.
Given that its role is to provide some stability against currency movements, I would not hold much more than a year’s worth of expenses in STI ETF and therefore will likely be adjusted down further as my portfolio increase in size. You will have to make a decision on how much you’d allocate to STI ETF based on your own circumstances.
Now that we’ve settled the local market fund, let’s take a look at the International Stock Market Index Fund.
International Stock Market Index Fund
On to the fun bits! The International Stock Market Index Fund is meant to provide the investor with exposure to public companies from around the world, ideally excluding the local market since we already have a fund dedicated to that above. The idea would be to get funds that hold as many public companies from as many countries as possible (both developed countries like U.S. and developing countries like China); as the world economy grows, so does our portfolio. Plus, we won’t have to care about which country will come out on top in the future (U.S. or China) because we own both.
Now, as Singapore investors you may keep hearing about Vanguard and their amazing index funds (like VTSAX) if you look at personal finance blogs from the U.S., however we don’t have access to their mutual funds here in Singapore. Thus you may think that the next best thing would be to get into the Vanguard ETFs that are listed on the US Stock Exchanges like the Vanguard Total World Stock (VT) with an expense ratio of only 0.10%, but not so fast!
Unfortunately for us, non-U.S. investors are heavily discouraged from purchasing any stocks through U.S. stock exchanges (U.S. domiciled stocks) due to the hefty 30% dividend withholding tax and up to 40% estate tax for any investments exceeding USD $60,000 in total value. This makes buying any U.S. domiciled stocks or ETF prohibitively expensive and out of the question for us Singapore investors.
So what are our options?
First, instead of looking at the U.S. stock exchange, let’s turn our attention to the London Stock Exchange (LSE.) There are ETFs listed here that attempts to achieve a similar goal of VT but are domiciled in Ireland, which removes the estate tax concerns and reduces the dividend withholding tax rate — which is now effectively a transfer between a U.S. company to an Irish company, with a withholding tax rate — of just 15%.
Let’s take a look at the ETFs that we have access to in LSE which could be our International Fund:
[Updated 29-Feb-2020] I have swapped out iShares Core MSCI World UCITS ETF (IWDA[USD] or SWDA[GBP]) for SPDR® MSCI World UCITS ETF (SWRD) which was launched last year (28-Feb-2019).
The swap is because they both track the same index but SWRD has a lower expense ratio (0.20% vs 0.12%.) Although SWRD is a much smaller fund (since it’s much younger – this means the trading volume is lower and could mean higher bid-ask spreads – if you are buying and holding for the long term, the difference in bid-ask spread won’t matter much.
I also believe the fund size as well as daily volume will continue to grow due to lower expense ratio so investors will being shifting funds over. The difference in expense ratio (though by just 0.08%) will be significant over the long term.
Disclaimer: Due to switching costs, I still continue to hold IWDA in my own portfolio.
- Vanguard FTSE All-World UCITS ETF (VWRD[USD] or VWRL[GBP]) – 3,130 companies from developed & emerging markets, large and mid cap companies.
- [Updated 29-Feb-2020] SPDR® MSCI World UCITS ETF (SWRD) – 1,634 large and mid cap companies from 23 developed markets.
- iShares Core MSCI EM IMI UCITS ETF (EIMI) – 2,800 all cap companies from emerging markets.
VWRD: The Simplest Option
VWRD is similar to VT in the U.S. but it is missing the small-cap companies that VT provides. It also pays dividends once every quarter in USD and is a good option if you are planning to live off of dividends eventually and not sell your stocks to fund your lifestyle. However, this also means that in order to reinvest your dividends during your investing years, you must manually use the dividend to buy more stock, which – if your dividend isn’t high enough in the beginning to be used to buy more shares – could leave your dividend sitting idle in your portfolio as cash waiting to be put to work again.
Despite that, VWRD is the simplest option with a good expense ratio that allows you to simply add both developed and emerging market companies to your portfolio in just 1 ticker. Simply add VWRD to your portfolio in the right allocation and your International Stock portion is done. Simple!
For more info on VWRD, you can check out the Turtle Investor’s short FAQ on VWRD.
SWRD & EIMI: The Developed & Emerging Market One-Two Punch
Disclaimer: Though I currently hold EIMI in my portfolio, I am not sponsored by iShare – but hey if they’d like to reach out, I’m all ears!
Although VWRD is the simplest option, it is not what I’ve selected for my own portfolio. What I did instead was to purchase IWDA (SWRD equivalent – see update above) and EIMI in combination in order to form this part of my portfolio.
Here are 3 reasons why I did not elect to use VWRD:
- The expense ratio of VWRD is 0.10% more than SWRD and 0.04% more than EIMI and every little bit counts when this is going to be the largest part of my portfolio.
- It distributes dividends – which means I need to manually reinvest the dividends myself. In the beginning, when my holding is small, the dividend distribution will not be enough to form a large enough lump sum to make another purchase of IWDA. This means it will often sit around in my account waiting for more money to be added to my brokerage account before I can use it as part of my funds to purchase more shares. In contrast, IWDA and EIMI are both accumulating, which means they will automatically reinvest the dividend for you and is already priced into the share value, thus your dividend is working for you at all times. It’s much more fuss free and less things for me to think about.
- SWRD and EIMI split allows me to have flexibility in how much I’d like to be exposed to developing markets vs. emerging market separately (I can choose 50/50 split or 80/20 split between SWRD/EIMI based on my risk appetite.
SWRD provides me with the developed markets exposure and EIMI provides the emerging market portion. Together, I will only be missing the developed markets small-cap companies from this group, which is probably fine as in contrast, VWRD is missing the small-cap companies from both developed and emerging markets.
The lower expense ratio is a nice bonus, but one of the nice things about SWRD and EIMI is that they are both “Accumulating” ETF, which means they do no distribute dividends and instead they automatically reinvest the dividends for you back into itself. This means I don’t have to wait to receive the dividend and manually reinvest, it is done automatically for me. Since I’ll be reinvesting dividends anyway during the wealth-accumulating phase of my journey, having this handled automatically for me is great. This means my dividend will never be sitting idle.
Having the developed and emerging markets in 2 separate ETF also allows me the flexibility to increase or decrease my portfolio exposure to either markets independently. That’s a flexibility that you can view as both a positive or a negative, but it’s good to note. At the moment, I try to keep the emerging market exposure to roughly 10% of my portfolio.
Having said that, both routes are great choices and you can choose either option to make up your International Funds and you’ll be fine. The easiest way to choose would be to ask if you’d like to receive your dividend as cash or would you rather it be automatically reinvested for you.
- Dividend as cash (VWRD)
- Dividend auto-invested (SWRD & EIMI)
Phew! Hopefully that was clear. Now, let’s take a look at bonds!
Bond Index Fund
Finally, last but not least is the Bond Index Fund. The role of the bond fund in the 3-Funds Portfolio is to provide stability and “smooth out the ride” as JL Colins of www.jlcollinsnh.com like to put it. (Check out his famous Stocks Series, it’s great!)
Bond prices are largely dependent upon the interest rate environment which changes much less often, in a slow and more predictable manner. This will mean that bond prices are much more stable and less volatile than that of stocks. Additionally bond prices tended to historically be inversely correlated with stock prices – meaning when stock prices go up, bond prices tend to fall and vice versa.
By adding bonds to your portfolio, when stock prices fluctuate and maybe falls sharply in recessions, the bond fund component is there to reduce the impact by moving in the opposite direction as the stocks. Of course bonds also has a much smaller potential return compared to stocks (1-2% for bonds compared to 7-8% for stocks in inflation-adjusted returns.) Due to this, most investment advice always recommend adding more bonds to your portfolio as you age to reduce risk at the cost of also reducing returns.
OK that makes a lot of sense, so what’s available for us?
For the bond fund, since we want to make sure it is low risk, we want to approach it in a similar way to either the local stock market fund (made up of SGD denominated bonds to mitigate currency risk.) With that criteria, we really only have 2 options here:
- ABF Singapore Bond Index Fund (A35) – Tracks a basket of high-quality bonds issued primarily by the Singapore government and quasi-Singapore government entities.
- Nikko AM SGD Investment Grade Corporate Bond ETF (MBH) – Tracks a basket of Singapore Dollar-denominated, investment grade “corporate bonds.” I think Financial Horse did a great analysis of this bond ETF here if you would like more detail.
|Total Expense Ratio||0.25%||0.30%|
|Fund Size||SGD $754.52M||SGD $290.51M|
|Yield-to-Maturity||2.34% p.a.||3.22% p.a.|
In terms of liquidity, neither of the Singapore bond ETFs has fantastic average daily volumes and thus suffers from a larger bid/ask spread (the gap between the price the sellers want to sell and the buyer wants to buy.)
After assessing my situation and looking at the options above, I’ve decided not to have a bond portion to my portfolio.
Wait what? Why don’t you have a bond allocation and what are you doing instead?
There are a number of reasons why I do not personally have a bond allocation in my current portfolio:
- Long investment horizon: Since I am relatively young, being only 33 years old, I have a longer investment horizon which reduces the risks from stock market volatility. Having the majority (even up to 100%) of my liquid investable cash in stocks allows me to capture higher average returns of equities and let compound interest more time to work its magic. Putting a portion of my investments into bonds now – while it lowers risk – also lowers the returns of the portfolio.
- We already have CPF: As Singapore residents, we are all required to fund our CPF accounts each month. The contribution can be as much as 20% of our paycheck – dropping lower as our income rises above the $6,000 cap – with another up to 17% contributed by our employer. These amounts are already being placed into the Special Account (at least 4% in risk-free return) and Ordinary Account (at least 2.5% in risk-free return). Given the amount we are already contributing to the CPF monthly AND the relatively high risk-free return we receive, we can view this portion of our networth as our “Bond” component and put the rest of our liquid cash into stocks instead. (Should you invest your CPF money?)
- Low volume, large spread & returns of the bond ETF: Lastly, the quality of the Bond ETFs are frankly not that great. The returns aren’t much higher than the CPF return (and is not risk-free), the liquidity isn’t good so the spread is large (means you end up paying a bigger premium every time you buy or sell.)
Based on the above, I decided to forego having a bond portion. However, if you feel that despite all the above points, you’d still like to build your bond portion, I’d probably go for the ABF Singapore Bond ETF due to lower expense ratio, higher volume, and larger fund size even though you get slightly lower returns since the bond allocation is meant for stability and not for gains.
One big benefit of having a bond allocation that is not your CPF is that it is liquid. This means that you can make use of it for rebalancing your portfolio when a recession hits. If stocks start dropping in value significantly, it is beneficial to have a bond component that has not gone down significantly that you can sell to buy stocks when stocks are cheap. Without the bond component, you may not have liquid cash ready to take advantage of the drop in stock price as all of your money is already invested in stocks.
Of course, if you are still employed and earning consistent income, you should be able to continue to buy into the stock market as prices drop – this does require to continue having a job when the markets are tanking (something that’s not a guarantee during times of market trouble.)
And there you have it! My thoughts and notes on how to construct a 3-Fund Portfolio in Singapore to set yourself up for long-term investment success! This is a pretty long post, which I think is good for going into adequate depth on a topic like this, but do let me know if you prefer content in long-form like this or more broken up in smaller posts instead so it’s not overwhelming.
Thank you for reading this far and I hope that this post was helpful. If you have your own take on the 3-fund portfolio that is different from what I’ve shown here, I’d love to hear it!
Of course, if you have any questions, suggestions or feedback please let me know in the comment section down below! You can also follow me on twitter if you want to have a conversation by tweeting @firepathlion! Thank you for reading!
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Until next time!