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

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Passive Investing: The Movie

Credit: http://www.flickr.com/photos/cheriejphotos/7158114527/sizes/m/in/photostream/It’s only 2 weeks into 2013 and I’m already swamped! These few weeks are absolutely packed for me, with work guzzling most of my brain fuel, and an upcoming work trip to Beijing. I’m also sticking with my 2013 goal schedule, as well as finding time to work on a free ebook (woot!) that will be making its way here soon, I promise!

So whenever life hits me with a gazillion things to do, I usually take things a little slower, kick back and do something chill like watch a movie. But because I’m a huge financial nerd, I get my kicks watching stuff like Passive Investing – an awesome 54-minute video on passive investing (duh) and why it rocks.

While there’re tons of books and articles written on the subject, I believe that this is the first time someone has made an entire documentary on it. The PF community has already been excitedly sharing it for a month or so now (yeah, I know, I’m a little late in the game.. my bad).

It features some of the biggest, badass (in a good way) names in the index investing industry, such as John Bogle, Kenneth French, William Sharpe, Burton Malkiel, and Rick Ferri. The production is pretty high quality, and there are summaries at the end of each chapter in case you get too distracted by the super strong British-newscaster accent.

So grab some popcorn, snuggle down on the couch, and enjoy 🙂

A caveat: While I agree with most of the concepts presented, I don’t fully agree with everything in the film. One of my biggest bugbears is their assertion that the Capital Asset Pricing Model (CAPM) is the “mathematical foundation of passive investing.” I won’t go into a snooty academic diatribe about the the flaws of CAPM here, but it suffices to say that you don’t need CAPM to hold in order to show that passive investing is still the best way to invest for most people.

Other than that though, the film is excellent. I also love how they display all the logos of actively managed funds throughout the film, subtly dissing the crap out of them without actually naming any names. It’s a little more subtle than my usual practice of pointing and loudly jeering at fund management ads displayed on the subway, causing people around me to move slowly away from me and whisper under their breath. I can only assume that they must be talking about how wise I am.

If you’re looking to learn a little bit more about passive investing but aren’t inclined to read a book, you could totally start here. It could be the most profitable 54 minutes you’ve ever spent. 🙂

Image credit: cheriej

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

ladder

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?