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

Advertisements

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.

Never Take Financial Advice from a Supervillian

I just caught the Dark Knight Rises last week. Okay, it wasn’t a terrible movie, but it’s just riddled with plot inconsistencies that I couldn’t resolve, like (SPOILER ALERT):

1. Why is there a random-ass prison in the ground, in the middle of some foreign desert, with no warden, no food, and a bunch of prisoners cheering each other on? And how did Bruce get to Gotham in like, 2 hours after escaping from said prison?

2. Once Talia dies a terribly unconvincing death, which eliminates the bomb’s mystery triggerman, why didn’t Batman just haul the damn bomb to the sea in the first place? (which would leave him a lot more time to make out with Selina Kyle?)

3. How was Jonathan Crane (Scarecrow in the first movie) planning to exile its rich citizens in the summer? (“You are condemned to exile… by swimming!” Wtf).

Stupidest Supervillian Financial Plan Ever

But the biggest plot inconsistency for a financial nerd like myself came from Bane’s hairbrained plan to bankrupt Bruce Wayne.  (Hat tip to this article from theatlantic.com).

  1. Take over the entire Gotham Stock Exchange
  2. Hack into Bruce Wayne’s account
  3. Buy lots of puts on futures that expire at midnight.
  4. Bankrupt Wayne so he’ll have to read cheerfulegg.com to learn how to get rich again

Let’s examine the loopholes in this plan. First, there’s absolutely no reason for Bane to hold the Gotham Stock Exchange hostage in order to break into Bruce Wayne’s account. A more subtle (and less risky) plan would involve breaking into Wayne’s brokerage, which probably isn’t located within the Exchange. Or better still, hire a hacker to break into his account online – certainly affordable for Bane’s considerable financial resources.

(Okay fine – a scene of Bane carefully keying in his banking token code into gothamnationalbank.com wouldn’t nearly be half as dramatic, and wouldn’t  make for good entertainment.)

Sexy Doesn’t Always = Smart

The biggest thing I’m confused about is Bane’s decision to buy a whole bunch of puts on Wayne’s account. If you don’t know what a put is, it’s a fancy-schmancy financial instrument that lets you profit when stocks go down (yes, they exist). And buying a whole bunch of them means you make a loooooooot of money when stocks crash – which is exactly what would happen if the stock exchange is under a supervillian attack. So Bane’s plan would actually have the opposite effect of what he intended – he would make Bruce Wayne so insanely, ridiculously rich that he could have outsourced the saving of Gotham to Spiderman or the Avengers.

My guess is that the scriptwriters just wanted to include the use of the word “puts” into the plot, because they sound oh-so-sexy. But as I’ve often blogged, the sexy thing isn’t always the smart thing to do. In fact, the unsexiest things you could do in personal finance are usually the smartest moves you could make:

1. Automatically saving a fixed amount every month, increasing it when you have an income increase,

2. Dollar cost averaging into a sensible portfolio of index-tracking ETFs.

3. Automatically paying off your credit cards in full every month to build your credit score, so you’ll get a lower interest rate if you ever need to borrow to buy a car/house/business.

Not nearly half as sexy as investing in hedge funds, or studying things like “delta” and “gamma”, or trading on volatility, or holding a stock exchange hostage, but they’ve proven to work over and over again. As Ramit Sethi often says:

“Do you want to be sexy, or rich?”

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.