The Great Index Unit Trust Hoax

Whenever I check into a hotel, I get really fascinated by just how crazy expensive some of the items in the minibar are.

One time when I was on vacation, I felt a little hungry so I lumbered over to the minibar and pulled out a pack of cashew nuts – just the regular kind you’d find at any convenience store. Just to be safe, I checked the prices before I tore the pack open, and involuntarily yelled: “NINE DOLLARS FOR A PACK OF TWELVE NUTS?! ARE YOU OUT OF YOUR FRICKIN’ MIND???”

It’s absolutely crazy how people are perfectly willing to pay several times the price for the EXACT SAME PRODUCT – a product that they could have gotten much cheaper elsewhere. We see this everywhere: a Nike sneaker vs a non-branded one, Tropicana orange juice vs a house brand, and beer that costs $12 in a restaurant and $2.50 in the supermarket.

A pack of nuts from the minibar might do a little damage to your wallet, but it’s nothing compared to the damage a unit trust (also known as a mutual fund for my American friends) could do to your long-term wealth.

Costs Matter

I’m not even going to discuss actively managed unit trusts with their high management costs. Nobody takes those seriously anymore – There’s more than enough research that shows that as a whole, actively managed unit trusts are a terrible choice compared to index funds.  Check out here and here.

Today, I’ll just uncover a pricing anomaly I like to call The Great Index Unit Trust Hoax, which involves 2 unit trusts being sold to Singaporean investors. Both charge exorbitant amounts to essentially help you invest in portfolios that you could have easily put together yourself… at a fraction of the cost.

To Infinity… and Beyond!

Exhibit A is the Infinity US 500 Stock Index Fund, which is supposed to help you track the return of the S&P 500. To accomplish this, it hits you with a whopping 0.98% expense ratio.  Now 0.98% may not sound like too much of a big deal, but try compounding that over 30 years and you’re talking about a difference of tens of thousands of dollars of extra cash that’s coming out of your pocket.

But hold on – there’s another, cheaper way for you to track the return of the S&P 500 on your own. You could buy an ETF from Vanguard, which gives you the EXACT SAME RETURN, while charging a mere 0.05% expense ratio. This makes the Infinity unit trust almost 20 TIMES MORE EXPENSIVE than the Vanguard ETF. Yeah, I know.

Home Sweet Home… For 4x The Price

Okay, I hear you say, so maybe that’s a problem unique to the USA.

Oh wait, it’s not.

Presenting Exhibit B, the patriotically-named unit trust MyHome Fund run by Singaporean asset management company Nikko AM. It invests in 1) an ETF tracking the Straits Times Index and 2) the ABF Singapore Bond Index Fund ETF. They’ll charge you a ridiculous expense ratio of 1.2% for all their hard work.

But wait! Did you know that you could totally log onto your online brokerage and invest in 2 ETFs which track the EXACT SAME THING for a fraction of the cost? Namely:

1. SPDR Straits Times Index ETF (SGX Ticker: ES3) – Expense ratio: 0.30%

2. ABF Singapore Bond Index Fund ETF (SGX Ticker: A35) – Management fee + trustee fee: 0.20% (I couldn’t find an exact figure for the total expense ratio on their website – those sneaky bastards – but it shouldn’t  be too far away from the sum of these 2 fees).

Total weighted expense ratio: 0.28%

Ta-daahh! You’ve constructed the exact same product, at a quarter of the cost. And that’s not taking into account sales charges, redemption charges, front-end charges, admin charges, and hire-an-attractive-banker-to-convince-you-to-part-with-your-money charges.

Do Yourself a Favor

My point here is to always, always, read the fine print. The finance industry loves to play down details like these because it means higher commissions for them – commissions that come right out of your pocket.

If you plan on investing passively, do yourself a favor and skip out on the unit trusts. You’re way better off buying the equivalent ETFs instead. Of course, there are a few disadvantages in buying ETFs (eg brokerage commissions, currency exposure, inability to invest in small amounts), but they can be easily circumvented (eg investing regularly using no-minimum commission brokers,  or in the case of the STI ETF, setting aside an amount every month until you can afford one lot). None of the disadvantages of ETFs justifies the tens of thousands of dollars you’re giving up in expenses if you invest in unit trusts.

It would be totally awesome if a reputable fund provider like Vanguard would set up an index fund in Singapore (are you reading this, John Bogle?), which would eliminate all the disadvantages in the para above, and yet charge a reasonable expense ratio that doesn’t require us to give up our first-born child.

In the meantime, stay smart and read the fine print. Save your money for those overpriced cashew nuts from the minibar. At least they’re tasty.

The Top 10 Investor Errors (And How You Can Overcome Them)

Have you ever checked out the finance section of your local bookstore? That’s usually the first place I zoom into, because I’m nerdy like that. The first thing you usually see is a SEA OF PURPLE in that hugeass shelf of Rich Dad, Poor Dad books. Don’t ask me why, but the gaudiness kind of turns me off. And then there are the shelves and shelves of books on awesome investment strategies: value investing, day-trading, swing-trading, volatility arbitrage, investing in wine/land/oil/Oompa-Loompa sex slaves..

For the amount of ink that’s been spilled to write about these sexy strategies, the hard truth is that 90% of investors will never be successful at any of them, because of their own inherent biases.

Barry Ritholtz wrote this great article on the Top 10 Investor Errors which I thought I’d share with you. If you’re just starting out in investing, or are thinking of doing so, I highly recommend that you read it – it’ll put you ahead most investors who don’t have a clue about the game that is being played around them.

The Top 10 Investor Errors:

1. High Fees Are A Drag on Returns
2. Reaching for Yield
3. You (and your Behavior) Are Your Own Worst Enemy
4. Mutual Fund vs ETFs
5. Asset Allocation Matters More than Stock Picking
6. Passive vs Active Management
7. Not Understanding the Long Cycle
8. Cognitive Errors
9. Confusing Past Performance With Future Potential
10. When Paying Fees, Get What You Pay For

At the risk of sounding like I’m under the influence of Error #8 (Cognitive errors – one of which is: “We selectively perceive what agrees with our preexisting expectations and ignore things that disagree with our existing beliefs.”), I’d like you to consider that a passive, low-cost, index-based, diversified and automatic (PLIDA) investment strategy will help you to overcome 9 out of 10 of these errors – pretty much everything except error #10 (because you don’t need to pay for a financial advisor). Check out my previous posts on investing if you need a quick refresher on a PLIDA strategy.

So how will PLIDA help you to be more baller than 90% of investors out there?

1. Investing in low-cost ETFs is – by definition – a low-cost strategy, which eliminates errors 1, 4 and 6. “Fees are an enormous drag on long-term performance… Typical mutual fund or adviser fees of 2 to 3 percent may not sound like a lot, but compound that over 30 or 40 years, and it adds up to an enormous sum of money.”

2. A diversified portfolio of index-tracking ETFs will take care of your asset allocation for you, eliminating errors 2, 5 and 7. When you’ve got a good mix of assets (say stocks, bonds, and real estate, diversified geographically), at least one of them will perform well at any given point, regardless of whether you’re in a bull or bear cycle.

3. An automatic investment strategy of dollar cost averaging, (investing the same amount of money at regular intervals while ignoring the price) will let you overcome the cognitive biases of trying to time the market, eliminating errors 3 ,8 and 9. Here, you don’t care about whether the stock market did well or whether the Fed is going to raise interest rates or what Ben Bernanke had for lunch today. You would calmly and surely stick to your strategy of investing, buying more when others are fearful (and prices are low) and less when others are greedy (and prices are high).

Meanwhile, back at the bookstore…

Go back to that finance section at the bookstore and try to find a book that’s written about PLIDA. Chances are, you won’t find that many. Not many people care to learn about the one strategy that offers them the highest chance of success. Instead, they prefer to bury themselves in their copy of Make Big Money And Retire Early By Investing With Covered Calls, and continue to delude themselves. How about you?

Don’t Walk Under Ladders

You know that superstition that says it’s bad luck to walk under a ladder? So we totally know that it’s based on myth and has no scientific basis whatsoever (If you’re curious, wisegeek gives a possible explanation on why this superstition exists), but we adhere to it anyway. Why take a chance, right? There’s this study that indicates around 70% of people in Britain still aren’t willing to walk under a ladder if another option exists (I’m still trying to figure out how the hell they managed to conduct that one – “Hey! Here’s 5 bucks, would you walk under this ladder please?”).

Here’s a possible reason why we stick to superstitions that we know aren’t true: BECAUSE WE DON’T WANNA DIE FROM A FALLING LADDER. It’s a sad way to go. I’d much rather die from taking a bullet to save someone’s life. Or flying a jet into the bellyhold of an alien spacecraft to save humanity. Or overdosing on delicious ramen from Ippudo. Or having too much sex. So I think the whole ladder superstition thing is to prevent an untimely Death by Ladder – and we stick to it because it just makes sense.

It’s entirely possible to adhere to something even though we don’t believe in it.

Anyone heard of the Efficient Market Hypothesis (EMH)? If you haven’t, check out this ridiculously boring Wikipedia article on it. Essentially, it’s this really cool academic theory that lots of professors and econometricians and financial economists believe in. It’s also the entire foundation upon which my Masters degree in Finance and Economics from the London School of Economics is based on…. and it’s also entirely wrong.

Say whaaaaaat?!

In a nutshell, EMH states that financial markets are essentially unpredictable, and that the only way to invest is to buy-and-hold an index fund – because while you can’t predict where the market will be in any given day, month, or even year, over the long run it will rise (because of various factors, which I outline here).

However, we now know that the EMH simply isn’t true. It’s been proven wrong over and over again by academic after academic after academic. But while we know that it isn’t true, it doesn’t mean that we should throw index investing out the window. In fact, even if we don’t believe in the EMH, passive index investing may still be the best way to invest.

Let’s look at performance

Okay, if the EMH isn’t right and financial markets are totally predictable, what’s the best alternative to index investing? Investing in a sexy, shiny MUTUAL FUND of course! (also known as “unit trusts” for my Singaporean friends) So these funds are run by really smart guys and girls, who have dozens of research teams under them and spend day after day analyzing the markets. If anyone could take advantage of predictable financial markets and beat the index, it’s them, right? Wrong.

Check out the findings from this paper, Passive Investment Strategies and Efficient Markets, by Burton Malkiel (yeah, I love reading nerdy academic papers in my free time because I’m geeky like that. Stop judging me).

“Over the 10-year period ending 31 December 2001, 71% of actively managed equity funds have produced total returns (including dividends and capital charges) that were inferior to the returns achieved by the index fund, after expenses… The same kinds of results have obtained for earlier decades.”

“In 1970, there were 355 equity mutual funds holding broadly diversified portfolios… Note that more than half of these funds did not survive over the 32-year period. We can be sure that the non-survivors had even poorer records than the surviving funds… Note that of the remaining 158 funds, only five produced returns that were two percentage points or more in excess of the index fund returns. Clearly, trying to select a winning fund is like picking a needle in a haystack. The likely result is to achieve well below average returns”

Smarter than the market?

So you can give me any strategy – value investing, momentum trading, small caps, technical analysis, whatever. It may work out well in theory, but the fact is that the majority of the professionals who have pursued these strategies were unable to beat the market at its own game. As Malkiel puts it: “Whatever predictable patterns may exist and whatever inefficiencies may occur, they do not give rise to profitable investing strategies.”

The success stories we’ve heard about – Warren Buffett, George Soros, etc are the proverbial needles in the mountain of haystacks of investment managers who have crashed and burned. The reality is that it is almost impossible to identify the next Buffett or Soros and invest in them.

And if the majority of professionals are unable to beat the market – I think it’s also highly unlikely that the average person, armed with his $49.95 book on Security Analysis, would be able to beat the market. Not impossible of course, just highly unlikely. Just sayin’.

Walking around ladders

As for me – I prefer to play where the odds are in my favor and invest in index funds. After all, they are far more likely to outperform the majority of investment professionals in the long run. Because while I don’t believe in the EMH or that walking under ladders may bring bad luck, why take a chance?

Why Whole-Life Insurance Is Like Picking Your Nose

There are some things that I would never pay someone to do for me. Like brushing my teeth. Or reading. Or organizing my iTunes library. Or picking my nose. Even if there was someone offering  these services on Craigslist, I wouldn’t pay him a dime because 1) he’s probably expensive as hell and 2) he would probably do a shitty job. Like I have serious doubts that a Professional Nose Picker would be able to offer as much nose picking satisfaction than what I would have been able to do myself.

Now think of an insurance company as a dentist offering additional professional nose picking services on the side. I’d pay him to protect my teeth – that’s his job. But hell to the no on the nose-picking services. He’d be expensive, and I could totally do it way better if I did it myself.

Whole-life insurance plans (also commonly known as “investment-linked plans”) is kind of like a professional nose-picking service. My insurance company’s job is to protect my family against the risk of a huge anvil plastered with the words “ACME” falling on my head. But it has no business poking its head in my investments, which should be growing as time goes by so that I can buy my own badass anvil protection.

But the sad fact is, most insurance agents are incentivized to sell you whole-life investment-linked plans, or a similarly pricy product. The result? Most Singaporeans blindly listen to them, because we assume that they’re “professionals”.

But the professionals may not always have your best interests at heart (Think of all the doctors who prescribe unnecessary -and costly- treatments because it helps to line their pockets, but that’s another rant I have altogether). There’s a better way to do this: Buy Term and Invest the Rest (or BTITR for short, because Singaporeans love acronyms).

So why BTITR?

1. It’s simple

Term insurance is the simplest form of insurance that exists. You pay monthly/annual premiums for a period of time, and if you die/get injured/get killed by Loki’s Chitauri army before the Avengers save you, your insurance company pays you a helluva lot of money. It’s simple – you’re not mixing your savings, or investments, or speculation, or livelihood, into your protection needs. Contrast this with whole-life insurance, where you have to worry about where you’re gonna invest your premiums, how your funds are doing, and argue with your agent on the administrative fees. Way too complicated.

2. It’s cheap

The premiums for term insurance are often around 10x less than those for whole-life insurance. You’re paying for the simplest protection needs – so there really isn’t much administration that needs to go into servicing your plan, which translates into a cheaper premium.

Tan Kin Lian (presidential candidate that got an embarrassing number of votes at the last Singapore presidential election, but gives really good financial advice on his blog nonetheless) estimates that you would pay only $10,800 over 30 years for term insurance, compared to $180,000 over 30 years for a whole life insurance plan with the same coverage. This table also compares how much cheaper your premiums will be for term vs whole life.

3. You get way better returns by investing on your own

This is my favorite part. Instead of spending a bomb on whole life insurance, buy term insurance instead, take the amount you saved and invest it in a low-cost index fund.

Using conservative assumptions, Tan Kin Lian shows pretty decisively that you would end up with more money by investing on your own instead of relying on an insurance company to invest on your behalf. To give you an idea of the figures, you’d end up with around $390,000 if you’d invested on your own after 30 years, vs approximately $270,000 if you’d relied on the insurance company to invest for you. And the difference is even greater if you extend the coverage period.

Why the difference? The key is that 15-20% of your premiums go into administrative fees and commissions for servicing your account in a whole-life insurance plan. And for the remaining 80% that does get invested into unit trusts (or mutual funds, as they call ’em in the US), you’re charged an annual “management fee” of 1-2% of your funds. After all of these fees, your whole-life insurance plan should return approximately 2.5% per annum, if you’re lucky. Contrast this to the return of an index fund like the STI ETF, which should return at least 5% per annum even if you’re conservative. The difference between 2.5% and 5% may seem puny, but extend that outperformance to 30 years and that translates into a whopping $120 grand.

So don’t be a pansy. Buy term and invest the rest, and have fun picking your own nose.

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.

How Not To Suck At Investing

Here’s the problem about investing – we know that it’s good for us, but most people suck at it. We all have an uncle somewhere who lost his entire retirement savings by betting on Asian stocks in 1997, tech stocks in 2000, or financial stocks in 2008. He held on to his portfolio as the market plummeted, losing thousands of dollars every day, until he couldn’t take the pain anymore and got out.. only to see the market climb back up again. On the flip side, we see research that says individual investors pulled more money out of the stock market…. only to watch the Dow march higher and higher. (as reported in the WSJ)

There are thousands of reasons why people suck at investing – behavioral biases, having way too many choices, overconfidence, etc – but I think the number one reason is that people just have the wrong idea of what investing actually is. Here’s what runs through most people’s heads when someone tries to talk to them about investing: “Investing… how to get rich! Picking stocks. What stocks do I pick? Maybe Facebook. Or Apple. Hope the price rises by like 10x next year and I’ll be RICHHHHHH. Ca$$$h money baby!!” Zomg. Kill me now.

Newsflash dude: Investing isn’t about picking stocks. I’ll say that again: Investing isn’t about picking stocks. Now say it to yourself three times every night before you go to sleep.

Okay I’m hearing the crowd of angry “investors” outside my door, armed to the teeth with pitchforks and torches right now: What?! It’s not about picking stocks?  But Warren Buffett, the world’s greatest investor, says we should pick good businesses at cheap prices, and hold them till like, FOREVER. And then we’ll be rich!! True, you could totally do that successfully… if you were Warren Buffett. He owns Berkshire Hathaway, a company of full-time, well-trained researchers and analysts who spend their entire careers searching for good companies to buy. He has contacts with Fortune 500 CEOs and can meet with them whenever he wants. He understands things about the businesses he buys that no individual investor can even dream about. Now if you think that simply picking up a book entitled “How to Pick Stocks Like Warren Buffett” and flipping through a few annual reports is going to make you a superstar investor… think again.

So investing isn’t about picking stocks. Rather, it’s about putting your money in assets that will grow over time and will generate an income for you. That’s it. Sure, you could plough your money into Facebook or Apple or whatever the hot stock is at the moment, but is there a chance that it could plummet to zero in 10 years? Of course. Companies fail all the time – all it takes is one CEO scandal, one accounting fraud, one new player on the market (think about what Google did to Yahoo), and your company, once the darling of all the investment pundits, is filing for Chapter 11. I’m not saying that individual stocks are bad investments – of course there are many that have a long history of excellent returns – but there’s another asset that provides awesome returns, with way lower risk than any single high quality stock you can find out there. It’s called the stock market. (cue dramatic music – bom bom bomm!!!).

Think about it – companies fail all the time, but it’s impossible for the stock market to go to absolutely zero, unless we get annihilated by a huge alien spaceship, in which case you have bigger things to worry about. The stock market literally comprises of thousands of stocks, and thus for it to go to zero would involve all the companies in it to go bankrupt – ie: extremely unlikely. Remember back in Finance 101 when they used to tell you that diversification is the key to successful investing? Well, buying the entire market effectively diversifies away the risk of any individual company. It’s not entirely riskless (to my financial nerds out there, you still have “market risk” to deal with), but it’s a whole lot less risky than owning any particular stock.

Another thing – the stock market has an impressive track record that’s freakin hard to match. I can’t think of any individual stock that has been around for the entire duration of the stock market’s 200-ish year old history, with a historical return of 7 – 9% per year, depending on who you talk to.

Okay, I’m hesitant to make the ginormous claim that the stock market always goes up – there have certainly been periods where the stock market has fallen, or stayed stagnant – but give it sufficient time (10, 30, 50 years-ish), and there’s a pretty high chance that it is likely to go up. Why do I think so? Three reasons:

1. Inflation – For most developed economies, prices rise. I don’t think we’re going to go back to those times where McDonald’s serves $5 extra value meals 24-hours a day. (no, those lunch hour deals dont count – I swear they cut the patties in half). Prices of things rise over time, including the prices of your stocks.

2. Survival – the stock market will always be comprised of awesome, solvent (ie: non-bankrupt) companies. If a company goes bankrupt, its stock is automatically removed from the stock market index, and replaced by another. Crappy companies get cut out, and replaced by better, sexier companies. Apple may be the most valuable company in the world right now, but in 30 years it could be bankrupt, and replaced by another trendy company where its fashionable for top management to wear tight-fitting black tees. Owning the stock market index ensures that your portfolio always comprises of the best companies in that market. It’s like being able to fire that one douchey, useless employee in your company, without the guilt or death threats.

3. Population growth – Let’s face it, even with the explosion of investable assets today, stocks remain the de facto investment vehicle of choice to most investors. They aren’t as sexy as fixed income or exotic options (I believe the job posting of “equities in Dallas” is still a laughing stock in the IB world), but nothing trumps the liquidity, the ease, and the transparency of the stock market. And as the world gets larger, more educated, and richer, guess where’s the first place they’re going to plonk their money into? That’s right – the stock market. And Economics 101 teaches you that as demand rises… so will the price.

Notice that everything I mention here is about really large, long-term macro trends. In all likelihood, prices will rise, good companies will replace bad ones, and the world population is going to get larger. I haven’t even talked about the number one economic reason why I think the stock market will rise: Because it’s comprised of businesses. Hundreds and thousands of businesses that earn more every year, year after year. Essentially, buying the stock market means putting your money behind the fact that business will continue throughout the world. And in my opinion, that’s a pretty strong bet, discounting the scenario that the world dissolves into anarchy and we all degenerate into Fred Flintstones. (Always wanted to try those cars with no floors that let you walk everywhere)

So how would you be able to own the entire stock market? It used to be ridiculously expensive to own the entire market because you would have to buy thousands of shares, but now you can do it with a low-cost index fund or ETF (but I’ll leave that for another time).

But don’t take it from me, take it from Warren Buffett, who mentioned that a low-cost index fund, is probably “the best investment that most people can make.” So you may not be able to invest like him, but you sure as hell could take his advice. Think about it 🙂

Some Good Investment Research… and Terrible Advice

I didn’t want to blog about investing till much later, but the Straits Times had an interesting article yesterday titled Stocks v Property. It deals with the issue of “Where the hell should I put my money?!” when it comes to investments. Everyone talks about investments, like: “yeaaahhhh I should really save up for a house… but it’s really expensive…” or “yeaaaahhh I’ve been meaning to invest for awhile now, but I don’t think I have enough time/money/interest…whine whine whine”. But very few people actually get off their ass and actually do some real research on what they should be investing in, so they either 1) don’t invest altogether, or 2) make some stupid investment decisions.

So an article like this gets some of that research done for you, which is awesome. I loved the first part of the article, which used numbers and statistics to back a case and destroy some common assumptions that we all have. The article should’ve just stopped right there, but part 2 of it gave some absolutely terrible investment advice, and I just had to say something about it, in a minute.

Some good investment research

From the ST article: “Retail investors, especially those in Singapore, tend to think of stocks as a short- to medium-term investment. When seeking a long-term investment, most Singaporean investors think of property first. 

But a recent comparison done by the Singapore Exchange (SGX) has shown that, in fact, local stocks have outperformed private residential property over the long run. In the 10 years from 2001 to 2010, the benchmark Straits Times Index (STI) gave an annualised return on investment of 4.9 per cent. Meanwhile, if you had bought property in 2001 and sold it in 2010, you would have made an annualised return on investment of 3.9 per cent over the period.”

Sure, the study excluded returns from dividends and rents, but add those into the mix and stocks have still historically outperformed real estate over the long run. And while 10 years is hardly considered to be the “long run”, other studies have shown that stocks have outperformed real estate over longer time periods (see this New York Times article).

Some terrible investment advice (esp if you’re young):

So the Straits Times article would have been awesome if it had presented the statistics, drawn a conclusion, and stopped there. But page 2 of the article had some terrible investment advice:

“Mr Vasu Menon, OCBC Bank’s head of content and research, noted that such wild swings in the stock market are even more prevalent today. As a result, he said, holding on to stocks for the long term is no longer a relevant strategy in this day and age.” (emphasis added).

“So even if stocks had outperformed property between 2001 and 2010, he said, there is no guarantee that they will do the same over the next decade. His advice: Set a target for your stock investments and have the discipline to stick to it. Say, for example, that you hope to make a 30 per cent return on a certain stock within three years. If the stock somehow reaches that 30 per cent target within six months, just sell, Mr Menon said.”

Hello?! Stocks are “no longer a relevant strategy in this day and age” just because the market has been volatile and uncertain? Mr Menon obviously needs a lesson in economic history: volatility and uncertainty are NOTHING NEW to the stock market. They’ve always been there – the Great Depression from 1929, the 1940s when stocks pretty much didn’t go anywhere, the “Black Monday” of 1987, the dot-com bubble of 2000, the collapse of Lehman in 2008…  and yet the US market has averaged a whopping 9.96% annually from 1920 to 2010. Volatility and uncertainty aren’t “unusual”, they’ve been characteristic of the stock market for the past 200 years. And anyone hoping to benefit from the long-run return of the stock market would have to learn to deal with these characteristics.

Next – Mr Menon is advocating that you cut your gains short by selling as soon as your stocks make a certain amount of profit. Sure, that might prevent your portfolio from turning into a loss, but it also prevents you from ever getting rich if the stock market does take off, leaving you sitting by the sidelines and whining like a baby. If you’re a young investor with a steady income and many years of investing ahead, then Mr Menon’s advice is absolutely terrible for you. He’s right that there is no guarantee stock prices will rise over the next decade – there are no guarantees when it comes to investments (unless you consider Ponzi schemes to be “investments”) – but over a long enough time period, there’s a pretty damn high likelihood that the stock market will come out on top.

So what the hell should you do?

Let’s be clear – your job isn’t to make sure that your portfolio makes money over the next 6 months, 1 year, or 3 years. Your job right now is to ACCUMULATE as many assets as you can. Since we know that stocks are ultimately likely to give you the best return over the long run, your job is to make sure that you have as many of those assets as possible, so that your returns will be multiplied across all those assets after a long, healthy period of investing! We’re talking 10, 20, 30 years here. Who cares if volatility wrecks havoc to your portfolio over the short run – it doesn’t make a difference because you’re not thinking of selling within the next couple of years anyway. Ignore the day-to-day fluctuations, ignore the uncertainty and fear that pervade the news, and ignore the stupid, complicated investment advice out there. Investing can be simple, straightforward, and best of all, automated (I’ll be blogging about that in time to come). Stick to your guns and accumulate as many stocks as possible, and you’ll be rewarded in the end.

To me, the answer is pretty clear: multiple studies, research and 200 years of stock market history have shown that the stock market is more likely to give you a better return over the long-term. Do I think that property is a bad investment? Of course not. The best portfolio would consist of both stocks AND real estate, among other asset classes. There’s way too much to say on this topic, so I’ll be blogging more about it as we go along. But I thought I’d start us off with a little taste of it here. 🙂