Little did I expect a pandemic to trigger the next economic crisis. The coronavirus outbreak that originated in Wuhan, China, has had a major impact on the global economy. Holding the largest share of global manufacturing output, China’s factory production halt has sent ripple effects throughout the world. Businesses reliant on China’s supply lines such as Apple have been affected by supply shortages.
Even if there were supplies, consumers lack spending appetite. As the growth in the number of COVID-19 cases shows no signs of abating, governments around the world have ordered their citizens to stay home to contain the spread of the virus. People are on furloughs or have lost their jobs since many businesses are hardly generating any revenue at all. As a result, consumers will tighten up their wallet and spend only on essential items such as food, toilet paper, surgical masks, and hand sanitizers until normalcy returns.
Gripped by fear, investors around the world have frantically sold down their portfolios. The S&P 500 has crashed 26.5% from its peak and is currently trading at a P/E of 16.2 — a level not seen since 2012. This black swan event has presented us with opportunities that comes once every decade, a great time to invest in quality companies that will generate good long-term returns.
When the Global Financial Crisis hit in 2008, I was new to investing. I didn’t know how to take advantage of the opportunity that was in front of me. Typical of an amateur investor, I bought some stocks, held on to the bad ones for too long, and sold the good ones too early for a tidy profit. For the next 11 years, I watched the S&P 500 appreciate by 257.7% from 2009 to 2019. Had I simply invested my money in an index fund, I would have made an average annual return of 12.3%.
S&P 500 return, 1 January 2009 to 31 December 2019. Chart: YCharts
It was a painful lesson. I hope you don’t have to go through the same journey as I did back then. Therefore, I’m going to share with you how I would invest $10,000 during this COVID-19 crisis. This is a guide for you on how you can build a portfolio with small sums of money. But don’t copy blindly. Take the time to understand the thought processes behind this guide and adapt them to your own financial goals.
Can you hold on?
The key to success as a long-term investor is holding power. As we zoom out and see from the 30-year S&P 500 chart below, the market can fluctuate wildly in the short run but in the long run it goes up.
S&P 500, January 1990 to April 2020. Chart: YCharts
Even if you bought the S&P 500 ETF at the worst possible time, right before it crashed in 2008, you will still make money if you held the stock till today. That’s because the S&P 500 always comprises the 500 best listed companies in the U.S. — if a company underperforms, it is replaced by a better-performing company in the index.
Once you understand this, you should never stretch yourself financially to chase after returns in the stock market — only invest with the money that you can afford to set aside for the next 5-10 years. You don’t want to sell your stocks at the worst possible time – during an economic downturn — just because you need the money. Further, you need to ensure that your personal debt is at a manageable level; and you and your loved ones are well-insured. You also need to have an emergency fund that can cover your living expenses for 6-12 months in case you lose your job.
Focus on quality growth
It’s rare to find high-quality growth companies trading at a deep discount. So when a market crash like the one we have now presents an opening, I’d rather use the opportunity to load up on high-quality growth stocks rather than on dividend stocks.
As you can see from the chart below, Nike, a faster-growing company, returned 694.6% from 2009 to 2019. In comparison, P&G, a Dividend Aristocrat, returned 102.0% over the same period.
Nike and P&G returns, 1 January 2009 to 31 December 2019. Chart: YCharts
It also makes more sense for me to invest for growth if I’m young to grow my capital faster. When I’m old, I can always reallocate that sum to dividend stocks to generate a passive stream of income to sustain my lifestyle. At the same time, dividend investing is great for those who cannot stomach volatility. The steady and growing stream of income from owning quality dividend stocks prevents them from panic selling.
For me, volatility is not necessarily risk. Price is simply a reflection of what the market thinks the company is worth at that point in time. When investors are optimistic about the outlook of the business, they are willing to pay more. When they are pessimistic about the future of the business, they will pay less. As investors, our job is to analyze and determine the right price to pay for the business.
High-quality companies possess wide economic moats, rock-solid balance sheets, and a long growth runway ahead of them. They are the ones most likely to bounce back higher after a crisis is over, grow their businesses, and create more value for shareholders which leads to higher stock prices.
How I would invest US$10,000
I want to own high-quality companies that I understand — mostly consumer-related businesses where I interact with their products/services daily. Understanding their businesses well enables me to be quick to spot if there are potential competitors out there by observing the behaviors of the people around me.
Here are my four personal picks:
- Alphabet (NASDAQ: GOOGL) or Google as we know it is the world’s largest online advertising platform. The company generated US$161.9 billion in revenue in 2019, mostly from advertisements from online properties like Google Search and YouTube. The road ahead is long and well-paved as the number of Internet users is projected to grow to 5.3 billion by 2023. The digital advertising industry is also expected to grow to US$517.5 billion by 2023.
- MasterCard (NYSE: MA) is one of the largest payment processing networks in the world. It has a ‘toll booth’ business model that generates revenue based on a percentage of payment transaction volume. The business benefits from the shift towards digital payments. Volume of card transactions in developed markets is forecasted to reach US$17.9 trillion in 2023.
- Facebook’s (NASDAQ: FB) business model is like Alphabet’s except that they sell advertisements through their social media platforms such as Facebook.com and Instagram. Since Q4 2009, Facebook’s number of monthly active users grew from 360 million users to 2.5 billion users in Q4 2019. This creates a network effect for them, making Facebook’s platform sticky as it’s very difficult for users to ditch their friends and family on the platform. Likewise, Facebook’s revenue has grown from US$777 million in 2009 to US$70.7 billion in 2019.
- Amazon (NASDAQ: AMZN) is the market leader in e-commerce and cloud computing. Through the years they have gained loyalty from customers from their sole obsession of making them happy — delivering high quality product at everyday low prices. Amazon passes down cost savings to its customers by spreading fixed costs over a larger number of goods sold. We must not forget that although Amazon is already huge with US$280.5 billion earned in revenue in 2019, they have more room to grow with a foot in multiple industries. The global e-commerce and cloud service market alone is expected to grow to US$5.7 trillion and US$331.2 billion respectively by 2022.
After doing my due diligence, I aim to allocate a quarter of my capital to each stock. While US$10,000 is great to start with, it is also not a very large sum and I’d prefer not to over-diversify my holdings as this incurs excessive brokerage fees. I have also greatly reduced my risk of permanent capital loss by owning great businesses with a margin of safety in place. If I want to, I can slowly build up my portfolio to 10 stocks later, investing in a new one each time I have another US$2,500 to spare.
Example of a US$10K portfolio. Note: This is neither a recommendation to purchase or sell any of the shares mentioned in this article, and the information here is for educational purposes and/or for study or research only.
As you can see, it’s not a perfect 25% per position because of the different prices. But I often allocate slightly more to companies that I’m highly certain of or if they are trading at a price much lower than their intrinsic values. What’s important is that these companies will not be heavily impacted by the COVID-19 crisis, and if any, the impact will be temporary. Most importantly, they all have strong balance sheets and enough liquidity to get through the economic downturn.
However, if I have no clue about investing and don’t want to spend so much time looking through companies, then investing in ETFs (exchange traded funds) is the way to go. By investing in the Vanguard S&P 500 ETF (NYSE: VOO), you get to diversify your holdings among the top 500 companies in America through an index fund. The portfolio will be rebalanced on a quarterly basis, giving more weight to larger companies.
At the same time, the index eliminates companies that underperform and includes new ones that have grown to the required size. You can think of this as an automated hedge fund without the high fees. Expense ratio for the Vanguard S&P 500 ETF is very low at 0.03%, below the industry average of 0.44%. That means for every $10,000 invested in the ETF, only $3.00 will go towards paying the fund’s total annual expenses. Not bad, huh?
If you lean towards tech stocks, we can also consider the Invesco QQQ Trust (Nasdaq: QQQ). This ETF tracks the top 100 non-financial companies listed on the Nasdaq, comprising technology companies like Microsoft, Apple, Amazon, Facebook, and Alphabet.
The Invesco QQQ has performed remarkably well since the Global Financial Crisis till end-2019 – clocking a 614.9% growth during this period compared to the S&P 500’s 257.7%. In that case, we can do a fifty-fifty split and include Invesco QQQ in our portfolio too.
S&P 500 and Invesco QQQ returns, 1 January 2009 to 31 December 2019. Chart: YCharts
However, investing in Invesco QQQ is more expensive with an expense ratio of 0.20%, 6.7 times higher than the Vanguard S&P 500 ETF. However, I don’t mind paying $20 for every $10,000 invested if it continues to perform better than the S&P 500.
The fifth perspective
To conclude, I just want to say that this is NOT a recommendation for you to buy and sell any stocks. I’ve laid these out to give you some inspiration on how you can build your portfolio. Stocks wise, you can never substitute other people’s opinions for your own due diligence. Once you know what you are doing, you will not panic when the stock market turns against you. There’s no better time to invest in your future than in a market crisis.
To end off, on behalf of The Fifth Person, I want to thank all the healthcare and frontline workers putting their health on the line for us.
‘Night is always darker before the dawn and life is the same, the hard times will pass, everything will get better and sun will shine brighter than ever.’ – Ernest Hemingway.
No matter how difficult, this too will pass. Hang in there and we will all get through this together.
Stay safe and stay healthy my friends!