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 🙂


Should I Buy 16 Exxon Mobils, or a Lump of Gold?

Everyone’s caught up in the gold bug these days. They see the meteoric rise in gold (check out the chart below) and their palms get all sweaty, they start breathing heavily, and they yell “GOTTA HAVE THAT AWESOME SHINY STUFF, AHHHHHHHH!!” Gold has risen a whopping 500% since 2000, especially during the last couple of years when everyone got really scared that the world was coming to an end. (I never got the logic of that: the world is coming to an end, and you think a piece of pretty shiny metal is going to save you?)

Even my dad, who got me interested in finance in the first place, turned to me really seriously one night and said “Gold should be an essential part in everyone’s portfolio”. He cited numerous convincing reasons: it’s an inflation hedge, the US dollar is falling, it’s the world’s ultimate reserve currency, etc etc. I didn’t really know how to respond to that at the time – it’s really easy to get swayed by complicated, convincing arguments on why you should buy gold, or junk bonds, or tulips, or Moroccan camels.

And then I came across this awesome article in Fortune Magazine written by Warren Buffett, the world’s greatest investor. It’s an adaptation from his upcoming shareholder letter – if you’ve taken a basic Finance 101 class, you can totally appreciate the obvious, simple truths in it. I loved this one particular analogy:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

Would you? I wouldn’t.

Today, you can put your money into hundreds of investments – A colleague complained to me once that there are just “waaaaay too many choices out there” – How do you choose? Personally, I find it a lot easier to make sense of the whole mess by taking Warren’s advice and looking at all the investment assets in the world as just three types:

1. Currency-denominated assets: Think bonds, money markets, CDs, or your simple POSB savings account. These are supposedly the “safest” kinds of assets to invest in, but you’re really losing money every day because of inflation.

2. “Bigger sucker” assets: Assets that never produce anything, but are purchased with the hope that another buyer will pay more for them in the future. I call these “bigger sucker” assets. Gold falls in this category, along with oil, internet stocks in the early 2000s, silver, cattle, lean hogs (no, seriously, you can invest in them), art, wine, country club memberships, and tulips during the 17th century. You buy them, and after the price rises, you can sell them to a bigger sucker who will pay more than you did. And yes, houses fall into this category too, if you don’t rent them out.

3. Productive assets: these are assets that produce more and more cash flow as time goes by. Think businesses (which produce earnings), stocks (a proxy for owning businesses since they pay you dividends), real estate (which earns you rents), factories, farmland, etc. Sure, the economy is pretty shitty right now, but is the Coca-Cola company going to stop selling Coke, or is P&G going to stop selling shampoos? Doubt it.

No prizes for guessing the best type of investment to put your money in. Hint: it’s not number 2, or whatever assets that’s hyped up at the moment. It could be tulips in the 17th century, or gold today, or Hello Kitty paintings in the Baroque style in the year 2050 (gawd, I hope not). Investments make a lot more sense when you just focus on the basics: when you invest in something, does it actually produce anything? Will it earn an income for you? If it does, you’re probably on the right track.

To my knowledge, there’s only one type of asset that has stood the test of time with 200 years of history, will allow you to invest in real, tangible productive assets, and is still doing amazingly well today. Ladies and gentlemen, stocks are the clear winner in this race. Name any other asset, and I’m willing to bet that they don’t have as long, or as awesome, of a track record as stocks have had.

Could gold outdo stocks in the next couple of years? Sure. But I’m pretty sure that a lump of gold the size of a baseball infield is not going to be more valuable than 400 million acres of farmland and sixteen Exxon Mobils in the long run, no matter how pretty it is.

It’s Not Always What You See

Came across this picture on Facebook today and loved it. The first of the 19 things your suburban millionaire neighbor won’t tell youOver the long run, you’re better off if you strive to be anonymously rich rather than deceptively poor.

Think that fancyass dude with the flashy sports cars, the country club memberships, and the expensive clothes must be helluva rich? Maybe… or maybe not. Paradoxically, a dude with a multimillion dollar income could be way poorer than you. Just ask the 60% of all NBA players who go broke 5 years after retirement. The mansions, the cars, the private jets – the owners had them all, yet couldn’t avoid bankruptcy.

Your millionaire neighbor? Probably drives a 9-year old car, lives in a modest house, spends less than what he earns, and pays off his credit cards in full every month. Warren Buffett, the world’s greatest investor, drove a humble 2001 Lincoln Town car with a license plate that read “THRIFTY”. He auctioned it in 2006 on eBay for charity, and subsequently bought the most expensive car he ever owned: a $55,000 Cadillac – probably cheaper than most cars in Singapore.

So screw jealousy. You can’t tell how rich people are just by looking at their flashy possessions.  Chances are, you just might be richer than them already. 🙂