The High Cost Of Bad Buy/Sell Decisions

Great-looking (and particularly eye-opening) graphic today from Visual News:

 

Totally in line with what I’ve been trying to say in my past few posts:

“The return of the average investor is 1.9% over 20 yrs — due to poor buy and sell decisions. Investors who simply invested — and kept — their money in the S&P 500 earned an average of 8.4% over the same period; with diversified portfolios doing even better.

The true problem lies in the fact that the majority of buy/sell decisions are wrong; even if you think you’re smarter than the masses. Barrons recently revealed that 85% of all sell or exchange decisions are incorrect.”

 

Dilbert’s Boss Ponders Market Timing

Love today’s Dilbert strip. Most people focus way too much on market timing – when should I buy and sell? Which is why I always advocate a system of dollar cost averaging – to take all that worrying out of the equation. 🙂

Sleazeball Finance

Have you ever been accosted by a scammy salesman? Like one of those douches who tries to smoothtalk you and be your friend, and then sells you a friggin stone that’s supposed to have healing powers and improve your sex life and make you lose weight? And before you know it, it ends up being a helluva expensive paperweight, and the only way it’s helping you to improve your sex life is when you ask some chick if she wants to come back to your place to check out your “really cool stone”.

I hate scammy salesmen. Like I wish I could round them all up, tie them to a stake, and dump like 8 billion ants on them. And then pour honey onto their testicles. (Or other parts if they’re ladies. Like, maybe their hair). And I don’t know why, but finance has the highest concentration of scammy salesmen (and women) I have ever seen in any one area.

I attended a forex seminar last year, where this charismatic dude gave a speech which was so disgustingly full of crap that I wanted to go on stage, stand on his table, and literally pee on him. He kept promising the audience that they would gain HIGH. SPEED. WEALTH. if they would only purchase his “Pip Maximizer”, “Profit Explosion”, and “100% Accuracy Technique” for a low, low price of $1,000!!

Let’s talk about the 100% Accuracy Technique. His claim: if you bought the EURUSD every year on the 24th of November and sold on the 6th of December for 8 years, you would have made a profit 100% of the time!!! ZOMG WOW LET’S ALL DO THAT RIGHT NOW AND WE’LL BE RICH!!! Ladies and gentlemen, this is a widely employed technique known as “backtesting” – where you would look at how a particular stock, or currency, or asset had performed in the past, and then use trial-and-error to find a trading strategy that would give you stellar results. There are so many permutations out there, it’s entirely possible to find hundreds of trading strategies that would give you amazing results, and if you had only traded them for the past 10 years or 7 years, or 1 year 9 months and 28 days, you would’ve been a gazillionaire by now.

The thing is, they may look absolutely perfect based on past performance by pure chance alone. In the past, maybe buying a stock when there was a full moon and Big Bang Theory was showing on TV would have made you a 500% return, but will that work in the future? THERE IS NO FRIGGIN’ GUARANTEE. There is no reason whatsoever that buying on 26th Nov and selling on 6th Dec would yield a perfect record in the future.

Yet, the hundreds of wide-eyed potential investors around me craned their necks forward when they heard about this amazing 100% Accuracy Technique, furiously scribbling on their notepads. It made me sick. Singapore is supposed to be one of the most highly educated countries in the world, but our brains turn to mush in the face of greed.

I’ve attended dozens of these scammy talks to try to understand the minds of people who sell and buy these scams. And I’ve come up with three ways to prevent you from falling prey to them:

1. Read a book. Seriously, understand how the hell things work before even trying to invest or trade in them. Amateurs see forex as an ATM for them to gain HIGH SPEED WEALTH. Pros understand that the forex market comprises of institutions, brokers, investors, banks, companies, hedge funds, who use it as a means of liquidity, risk management and speculation.

2. Always question promises made. They will make you a gagillion promises and cite their hundreds of success stories who made it through and are earning a passive income of $10,000 a month working from home. Question how they got those results. Were they backtested? Was it a one-off occurrence? Could the data have been manipulated?

3. If you find yourself rushing to buy it, it’s probably not a good idea. 9 out of 10 of these scammers employ a tactic called “time limitation”. They dangle an attractive discount in front of the audience, and declare that it’s only open to the first 50 people who sign up for it, or that it’ll close in 15 minutes. This has two effects – 1) It restricts the supply, which makes it more attractive and 2) They make you feel like you have to act NOW, which is almost always a dumb decision. Most, if not all, good investments are made after careful, controlled, rational thought. NOTHING is worth buying or investing in at that very moment. Take at least a week off to ponder your options before arriving at any decision, even if it means losing that awesome discount. In all likelihood, you’d be able to bargain it back again should you choose to invest later.

All in all, BE SKEPTICAL whenever you’re about to purchase anything. If it sounds too good to be true, it probably is.

Have any of you met scammy, sleazeball financial salesmen or agents who used underhanded tactics to get your money? Share your experiences!

Smarter Than The Market?

So I attended Invest Fair 2012 this weekend, which was pretty much a marketplace of financial service providers, brokers, insurance companies, and the occasional weird individual trying to tout his own “proprietary” trading system. It was exactly like a marketplace, the kind you’d find at your local heartland HDB estate, with energetic sweaty speakers gesturing at candlestick charts and yelling to crowds of wide-eyed middle aged folks, craning their necks and shoving to get a glimpse of the Secret Millionaire Trading Strategy to Make You Rich. You would’ve thought that the speaker was selling fish, or vacuum cleaners, or a Ginzu Knife, instead of a “highly sophisticated automated trading system”.

Interestingly enough, I didn’t see anyone talk about passive indexing in the 4 hours I was there. There was a brief mention of it in one talk, but the speaker put it way down below in the investing hierarchy. Speaker: “If you don’t have enough time at all, and you ONLY want the market return, you can opt to do passive indexing. That will get you between 7%-11% a year. If you have a bit more time, you can do value investing and momentum investing, which can give you up to 20% a year. But the most profitable of all, the style that I use, is to invest in small caps. That will give you up to 30% a year, but you have to stomach a lot more volatility.”

Now, 30% a year sounds like a helluva attractive option, doesn’t it? Hell, you could double your money in less than 3 years! But let’s think about this for a second.

Why you’re not likely to be smarter than the market

If you make a 30% return in the market, there must be someone else (or a bunch of other people) on the other side of that trade who lost 30%. Every time you buy a stock, there is someone on the other side selling it to you. And every time you sell, there is someone on the other end buying it from you. Every time you win, someone else loses, and every time you lose, someone else wins. Lots of people forget that the stock market is a zero sum game, and you are playing against other people. Now, say you bought a fancy trading strategy at the investment fair and started making 30% a year consistently. This means that you would be consistently beating the majority of the other players in the market, ie: you would consistently be in the “winning” half of the market.

Now think about who the other players are. First, there are the institutional fund managers and mutual fund managers with billions of dollars under their control and have the power to move the market every time they trade. Then, there are the brokers and the flow traders who have a first-hand view of the order books and could front-run you without you even realizing. There are also the hedge fund managers, who hire Nobel Prize winners to develop algorithmic trading strategies for them. There are people like Warren Buffet, whose sheer influence and ownership of certain companies gives them access to information that no one else could possibly access. And then there are the high frequency traders, whose machines execute millions of trades a second. And then there’s you, with your $500 trading system you bought from Invest Fair 2012, and your $99 book on technical analysis. Now, who’s more likely to consistently be on the winning side of the market?

I’m not saying that you’re stupid. In fact, it’s very likely that some of you reading this would have made some money trading some fanciful strategy so far. All I’m saying is that by definition, the majority of you will be painfully average in your ability to beat the market. And once you add the professionals to the mix, it’s more than likely that you, the average retail trader/investor, are likely to be in the losing end of the market if you’re going to play against them. Most of us would like to think that we’re smarter than average – a behavioral bias of overconfidence that makes us think that somehow, we’re that one special person blessed with gifted intelligence and luck that will let us triumph over everyone else. But by definition, that cannot be true for most people, including people like you and me.

So let’s not kid ourselves that we can be consistently smarter than the market. The market consists hundreds of thousands of other participants, some of who are much, much, much smarter than you are. If one or two screw up, there are plenty more to take their place.

Embracing Average

Okay this all sounds very depressing, and it sounds like we should just all get out from the investment game altogether and stuff our money in pillow cases. But wait, there’s hope! Let’s think about things a little differently – let’s entertain the thought that maybe being average is a good thing.

Here’s why – we all know that on average, the market increases by about 8% a year. This 8% is the result of aggregating the entire market’s gains and losses: the mutual funds raking in 20%, the hedge funds blowing up, a retail investor losing everything, and your uncle who got lucky and jumped into tech stocks which rose by 40% in 3 months. Add them all up together, and it averages out to about 8% a year. (it works out to 8% a year, not 0%, because there is a strong upward bias in the market, helped by the fact that businesses in the market grow their earnings as time passes) So when you buy the market and hold it forever, you’ll experience some good years with double-digit returns, and some bad years with scary negative returns, but on average, you’ll be hitting approximately 8% a year.

Honestly, how many of you have been able to consistently rake in 8% a year? I’m willing to bet that the majority of retail investors won’t even come close to this figure. So why bother spending money on trading systems, or financial adviser fees, or commissions, just to earn less than the market return? Do yourself a favor and practice passive indexing – you’re pretty much guaranteed to beat the majority of the masses out there, the same ones who cluelessly invest in small caps (or other things) because they want to earn 30% a year, and think that they’re smarter than everyone else.

Just In Case

So I’m just gonna say it – I’m a really big wuss when it comes to personal finance.

Some of my friends get a big kick by bragging about how they lose like thousands of dollars every day on their own accounts. I totally get it. Hell, I’ve been there before. I used to watch the futures and forex markets all the time, throwing my dad’s money down and watching with nail-biting intensity, mentally willing those little candlestick charts to go in the direction I wanted, as if I could control the markets if I just concentrated hard enough.

Some of my other friends take their entire life savings and throw them into commercial properties, apartment-flipping, businesses, and art. It’s a helluva sexy isn’t it? Like it could totally be the plot of one of those rags-to-riches movies. (Raspy-voiced narrator: “He started with nothing. Life was tough on the streets. But one man would overcome the odds, take all the risk… and emerge a winner” Cue: inspiring music)

Some people view investing with a “go hard or go home” philosophy – by throwing everything into it. But just because you did a heroic Hail Mary pass doesn’t mean that the market, or your investments, are going to romantically work out for you in the end. If you throw your entire weight behind one, glorious, inspiring, guns-blaring Blitzkrieg, you’re going to be caught with nowhere to run if it doesn’t work out for you.

I’m all for investing, but let’s be smart about it. First, I’d recommend building a hugeass emergency fund. Like 6 months of your income would be good. A year’s worth would be better, but not necessary if you’re young since it’s probably not gonna be that hard for you to find another job if you lose yours. But yeah, there’s nothing more reassuring than having a cool pile of cash sitting in your bank account.Totally baller.

One more reason why having an emergency fund is awesome – it helps you to keep a cool head. And having a cool head is absolutely critical to your success in investing. Here’s a fun fact: the number one reason why most people don’t succeed in investing is because they care too much about it. When the market tanks, most people panic and sell their holdings, which is almost always the wrong decision to make. With an emergency fund, you’re not dependent on your investments to pay your bills, so you won’t go making stupid decisions with your investments.

Secondly, make sure your savings are covered. If you’re planning on buying a house, or getting married, or having a kid, save for those and keep them separate from your investments. Investments, by nature, involve a certain amount of risk, and depending on what you invest in, you don’t want your kids’ college fund to disappear when the stock market takes a nosedive. I have a separate long-term savings account that I contribute towards every month, and I never, ever touch that, not even to buy more stocks.

Next, split your salary and work towards building your emergency funds, your savings, and contributing towards your investments. Personally, I concentrated on building up 6 months’ worth of my salary for my emergency fund first. With that done, I could focus on allocating my money purely towards savings, investments, and expenses.

Lastly, if your investments are relatively low-cost like stocks or bonds, I’d recommend using strategies like dollar-cost averaging to diversify your risk over time.

That’s it! No sexy strategies, no Hail Mary passes. Just smart, common-sense investing, which, in all likelihood, will let you come out ahead in the end.