On understanding risk when it comes to investments
The answer booklet to the TWS Common Test ran on our IG stories!
ICYMI, we ran our latest iteration of our TWS Common Test over on our IG Stories (click here to try it out if you haven’t already!).
We thought that it’ll be useful to explain the answers here so that you can understand the reasoning.
But before you check out the nerdery below, do subscribe to our Substack (if you haven’t already) so you don’t miss any of our newest content!
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(Just a dislcaimer before we begin: we understand there might be more than one answer depending on the situation, but this is just our rationale and how we would approach the situations we described.)
Answer: A (Keep working for as long as possible to save money)
Ah Kow should have CPF Life if he is gainfully employed, but the payouts are provided monthly only. Thus it will be good for him to build up more savings in the event of emergencies — especially since once he retires for good, it will be hard for him to build his emergency funds back. (Either way, the other options present a lot more risk for a retiree.)
Not B, because your kids are not your retirement plan! Unless you want to risk impeding your kids’ financial growth (or risk your kids bearing grudges).
Not C, because Ah Kow only has a short runway of five years to invest. Stocks that can potentially give one higher returns also come with higher risks.
For example: The S&P500 was at $1,436 in 29 September 2000, and only rose back to ~$1,430 in 19 Jan 2007, seven years later. If Ah Kow had his money invested in 2001, he would have made a loss if he had to cash out in five years.
Not D, because investing in cryptocurrency is an extremely speculative investment and may rise or fall in value extremely fast.
Further reading: How I’d help my parents allocate their $$$ in 2022 (if they asked)
Answer: D (Put the money into his CPF Life account so that he can get a higher monthly retirement payout)
Money added in CPF Life is not ‘withdraw-able’, and is distributed via monthly payouts. And even if he is tempted to gamble his money away, he will only have a limited amount to gamble. (Though he really should just stop gambling la.)
Not A, because if he has a gambling habit and has access to a lump sum of cash, he might be tempted to gamble it away.
Not B, because… pls why are we encouraging his gambling habit. 🥲
Not C, because even though this sounds like a legit answer, if Ah Kow manages his own account, he can easily withdraw the principal sum to gamble it away too.
But if you, Ah Kow’s child, manages the account, that is a feasible option too.
Answer: B (How you feel about investment losses vs. how much loss you can financially handle)
Risk tolerance refers to client’s ability and willingness to take on investment risk, or how you feel about taking on risk.
Risk capacity is fact-based, and is based on how much risk they are able to take on their net worth, cash flow, and time horizon.
Answer: B (High risk tolerance and low risk capacity)
In this case, Ah Kow has a higher risk tolerance, because he is a gambler and is willing to take on high risks for high rewards, even if there is a high possibility of losing all his money.
Ah Kow has a lower risk capacity, because he has:
A shorter time horizon because he is already close to retirement age, and might not be able to keep his money invested for long as he will need it for his spending needs.
Limited financial capacity as he only has 6 months of emergency savings, and investing further will limit his liquidity.
Answer: B (An 80% chance to win $4,000 (and a corresponding 20% chance of winning nothing)
Risk-seekers are willing to take on more risk for the possibility of getting more in return.
Answer: C (Liquidity Risk)
Liquidity risk is the risk of not being able to quickly and easily transact one’s investment for cash, without substantial loss, when you need to.
For example: Art as an investment has high liquidity risk because there is no set price list for art, and there is a limited buyer pool. So if one decides that they would like to liquidate an art investment piece the next day, the likelihood of that is not 100% certain.
Not A: Inflation risk is the risk that inflation will erode the purchasing power of your investments over time.
This means that even if your investment earns a return, that return may not keep pace with inflation, resulting in a decrease in its real value (what you can actually buy with the money).
Not B: Interest rate risk is the risk that arises when the absolute level of interest rates fluctuates.
For example: if interest rates rise, the value of an asset (such as a bond) falls. We talk more about how interest rates affect investments here.
Not D: Market risk is also known as systematic risk, and applies to the performance of the entire investment market. Examples of market risk include recessions, political turmoil, natural disasters and terrorist attacks.
Answer: D (Investing in Singapore Savings Bonds)
The Singapore Savings Bonds is fully backed by the Singapore Government so the risk of capital loss is extremely low. Yes, the current SSB rate is 3.1%, which will still be outpaced by 4% inflation. But the other options are still risker…
Not A, because investing in stocks contains a high amount of risk, as your capital is not guaranteed.
Not B, because forex trading is extremely risky. Currency exchange rates constantly fluctuate due to various economic, political and social factors, which makes it hard to predict price movements.
Not C, because even though the risk of capital loss is extremely low as well, the returns of a childhood savings account in Singapore is ~ 0.05%. So your money faces inflation risk.
Answer: C (Focus on capital-guaranteed investments with guaranteed returns)
Even though such investments may not promise you high returns, it will also not fluctuate in value.
Examples include fixed deposits, government bonds, cash management accounts with guaranteed returns by robo-advisors and some endowment plans.
But do note that the returns of these investments are not high as well, and may not beat inflation. Thus, consider building a diversified portfolio.
We talk about how we invest here.
Not A, because a well-known company’s stock is also subject to fluctuations.
Not B, because even though the S&P500 and STI-ETF are well-known funds, they rise and fall in value.
Not D, because even though Singapore property as an asset class is known to rise in value, there are many factors that affect the selling price of a property, including supply and demand, interest rates, condition and age, and government policies.
For example: Stacked Homes did an article on condos that lost money.
Congratulations! Whatever your score, we hope you learnt something.
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