You Only Live Once

credit: http://www.flickr.com/photos/49568889@N08/7684077336/sizes/m/in/photostream/

I’m a HUGE fan of Lonely Island. Came across this awesome music video titled YOU ONLY LIVE ONCE, feat Adam Levine and Kendrick Lamar (who?).

I love it because it makes fun of people who take risk a little too seriously (“Two words about furniture: KILLING MACHINES!!”).

But while we scoff at the idea that we should stop going to clubs because loud music is bad for your ears, it amazes me that so many young people adopt that very same mindset when it comes to investing.

Here’s an interesting thought: Investing in the stock market is risky in the short run, but it’s the safest investment you can have in the long run.

The stock market is risky in the short run

Let’s tackle the first half of that last para first. Check out the returns from the stock market’s five worst years, from Financial Ramblings:

  1. 1931, -52.7%
  2. 2008, -33.8%
  3. 1930, -33.8%
  4. 1937, -32.8%
  5. 1974, -27.6%

So yep, in the very short term, buying and holding stocks is risky. Based on what history tells us, you could lose as much as half of your portfolio in a single year – Investors sure as hell weren’t popping champagne in 1931.

But it kicks ass in the long run

But it’s a very different story when you’re holding stocks for long periods of time.

Jeremy Siegel (whose classes I used to crash in college to leech off his market insights – woot woot!) argued in Chapter 2 of his book Stocks for the Long Run, that with a sufficiently long holding period, stocks are actually less risky than bonds.

According to Wikipedia, “During 1802–2001, the worst 1-year returns for stocks and bonds were -38.6% and -21.9% respectively. However for a holding period of 10-years, the worst performance for stocks and bonds were -4.1% and -5.4%; and for a holding period of 20 years, stocks have always been profitable.” Bonds, however, once fell as much as -3% per year below inflation.

In short, Siegel found that if you held stocks for 17 years or more, you never lost money even in the worst case scenario. 

Okay, so critics might claim that his findings are way too optimistic, and that the stock market’s prosperity in the 20th century may not necessarily repeat itself. But what’s the alternative? Investing in scammy gold buyback schemes?

The truth is, based on any historical record so far, the safest, and best, long-term investment for most young people has clearly been a diversified portfolio of stocks. Yes, even after you account for the stock market crashes in the past couple of years.

Young Heart, Run Free

And therein lies the awesomeness of being young and sexy – as young people, we have the luxury of having enough time. Enough time for a long career of earning money ahead of us. Enough time to hold on to our stocks without worrying about their fluctuations in any given day/month/year, knowing fully well that in the long run, we’ll come out on top.

So please. Stop getting intimidated by the stories of banks failing, and quantitative easing, and Justin Bieber’s Twitter account getting hacked. These are all short run risks (especially if you’re Justin Bieber), which are irrelevant if you’re holding out for the long term.

Take a little bit of risk in the short run to enjoy some awesomeness in the long run.

You only live once.

Image credit: TheOnyxBirmingham

5 Surprising Truths About Investing in Real Estate

Singaporeans are absolutely crazy about property. Whenever I walk into a bookstore, I see shelves upon shelves of real estate investing books with pictures greasy men in business suits on the cover, wearing a big smile and screaming “I Got Rich Making Big Money Investing in Real Estate, AND YOU CAN TOO!!”

I hate those books. One day, I’m going to write a book with a naked picture of me on the cover, wearing nothing but a big smile and screaming “I Published a Book With A Picture of Me In a Birthday Suit, AND YOU CAN TOO!!” And I’m going to get the bookstores to stack ‘em right next to those damn real estate books.

I get really puzzled whenever I talk to someone my age about investing, and hear that they would rather “just invest in property”. Those greasy men in business suits can’t be that convincing, can they?

I’m probably going to piss off every single real estate agent in the world by writing this, but I can think of 5 reasons why real estate isn’t the best investment for young people:

1. Your first house isn’t an investment

Most people who buy a house more expensive than they can afford justify it by claiming that it’s an “investment”. Let’s be clear here – your first house is a place to live. It is NOT an investment. Even if your house rises in value along with every other house in the country, whatever you gained from selling your house would just go right back into purchasing another place to live in.

2. Property isn’t necessarily safer than the stock market

Most people think that property is “safer” that the stock market. But really, if you’re lumping ALL your savings into one house, how diversified is your investment portfolio, really? Compare that to investing in the Straits Times Index (STI), which immediately diversifies your investment into 30 stocks, each backed by a real, physical, blue-chip company.

By the way, you can lose money in real estate. Anyone remember 2008?

3. Property may not give you a better return than stocks

An SGX-led study showed that if you invested in Singapore property in 2001 and held it until 2010, you’d be worse off than if you had simply invested that same amount in the STI. Globally, stocks may or may not outpace real estate in any given year, but stocks have historically performed better than real estate over the long-term.

A New York Times article also described how real estate in the US has only barely managed to keep up with inflation, while stocks have risen comfortably above inflation for the past 200 years. As Yale economist Robert Shiller puts it, “from 1890 through 1990, the return of real estate was just about zero after inflation.”

4. Costs will destroy a large chunk of your returns

If someone bought a house for $250,000 and sold it 5 years later for $400,000, most people would think, “Great! I made $150,000!” But they failed to account for all the associated costs that go along with it: Taxes, agent fees, commissions, insurance, maintenance, stamp duties, renovation costs, furnishing, etc, which would add hundreds, if not thousands, of dollars to your monthly bill.

Let’s not forget the interest you’ll have to pay on the housing loan you took out, which is easily in the ballpark of tens of thousands of dollars. For Singaporeans, if you use your CPF to purchase a house, you’d have to pay back the amount you “borrowed” from CPF, PLUS INTEREST (It stands at 2.6% today, but it’ll rise once interest rates go up. I totally see the rationale of this policy from the government’s perspective, but am I the only one who thinks this is a crappy deal from an investing standpoint?).

The costs I pay for investing in a low-cost ETF? A commission of $25, and an annual expense ratio of 0.3% (For every $10,000 invested, that’s like thirty bucks).

5. Mortgages screw with your psyche

“Hey, let’s use other people’s money to get rich!”… is what most people would tell themselves before taking on a huge-ass mortgage.

Dude, a mortgage isn’t something to scoff at. It’s as full-fledged and serious a commitment as… marriage. Things change once you’ve got the ever-present threat of a monthly mortgage payment hanging over your head. You start to see things differently. Mortgages cause people to become way more risk-averse, and less likely to do things like finding a better job, starting their own business, and investing, even though those options may help them to become financially better off.

Think of it as a Big Buy – Not an investment

I’m not saying that real estate is a bad investment. You can make money from it if you already have 1) a house to live in, 2) lots of spare cash, and 3) a strong portfolio and are looking to diversify your investments.

But most young people don’t fall into this category. Instead, we should see our first property as a really, really, really large purchase rather than an investment. Think of it as a great way to build equity and start a family. But please don’t delude yourself into thinking that you’re going to get rich from it. If you’re just starting out, you’d be better off focusing on building a sensible portfolio of stocks and bonds.

Agree/disagree? Leave a comment or send me an email at cheerfulegg [at] gmail [dot] com. I’d love to hear from you, especially if you’re interested in publishing my birthday suited book cover.

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.