Hi readers,
As i was chatting with a friend about how Moderna and AMD have rallied in the past year, it dawns on me that these stocks have gained multiple times in terms of their prices, all these with the pandemic in the background.
Let’s face it, not many of us have the perseverance of holding on to winning positions. I have sold AMD at an earlier stage when the price was around $100. I am facing the same issues as many investors out there as well. Though my understanding is always hold on to winning positions. To be honest, on the chart, it seems that there was a resistance at $100 and i wrote about AMD earlier (Report here). As such, my intention is to sell first and buy back later when the price pulls back after hitting resistance. Of course, today we know that the price didn’t pull back but continue on its upward trajectory. Last night, AMD closed at $117.80, a hefty 17.8% more in just a couple of days.
From the above example, having knowledge and understanding is one thing, to execute the plan is totally a different story. As such, i hope that I can share some knowledge and understanding here so that my readers can benefit from it. Of course, I will leave the emotional part of executing the plan to you, which in my opinion, is the most difficult part.
Why investors should not be selling stocks?
The probability of the market going up is higher than it going down over time. Since 1950 to 2020, the S&P 500 has grown by a tremendous 22,190% (212,524.72% with dividends reinvested!). Despite world wars, pandemics, and every sort of crisis thrown in, the market keeps rising. This is due to many factors which include growing global population and higher standard of living, just to name a few. The internet is filled with tons of articles and researches on these and do google them to read in more detail if that is something interesting to you.
With the above in mind, i will use an example to illustrate:
Assuming, we are not good at stock picking, and perform averagely in this area. We bought 10 different stocks using a total capital of $10,000, evenly distributed among these ten stocks.
Let us see how these stocks perform over time. In this example, since we are average stock pickers, we assume that out of these 10 stocks, 3 of them (A, B and C) perform precariously and 2 of them (X and Y) perform outstandingly. The remaining 5 of them (D, E, F, G and H) are not moving at all (hardly the case in real life).
Stock A, B and C drop 20% each year and Stock X and Y gain 20% each year. While the rest of the stocks neither drop or gain. As you can see from this scenario, I am trying to be very pessimistic in my assumption. Not that easy to find 5 stocks that stays the same over time. You add that 2 stocks that are performing precariously, your hit rate is actually only 20% (2 stocks out off 10 stocks).
Below is the result that i have generated using excel:
It is quite surprising to discover that in such a pessimistic scenario, not factoring in any dividends along the way, our portfolio continues to generate a whopping return of 77% after 10 years. The annualised return is 5.88% per annum though the portfolio only broke-even in the third year.
Why is this happening?
I believe that many readers will be asking, why is this possible. The answer is simply, the science of maths; if there is such a term. I made it up:)
Let me explain. The 3 stocks (A, B and C) that are losing 20% each year, the valuation gets smaller and smaller. Thus the 20% loss annually becomes lower and lower. Vice versa, the winning stocks (X and Y), the 20% gain is getting bigger each year.
At the end of Year one, stock A , B and C is worth $800 each and 20% of it is $160. At the end of year 2, Stock A, B and C is worth $640 each and 20% of it is $128. So here, we can see that the losses get smaller and smaller.
At the end of Year one, stock X and Y is worth $1200 each and 20% of it is $240. At the end of year 2, Stock X and Y is worth $1440 and 20% of it is $288. So here, we can see that the winnings get bigger and bigger.
Let’s change some parameters and see how the portfolio performs. Assuming the 5 stocks that never change, they have an annual dividend of 2%, which is pretty low by market standard. For the record, dividend yield for STI is currently 3.56%. So we can see that i am using a pessimistic number again. Dividends collected are reinvested into the same company.
The annualised return has just being increased from 5.88% to 6.52% for a 10 years period! What we are seeing here is the compounding effect of reinvesting dividends over the years. Of course, the earlier example is also reflecting the compounding effect of investment return.
It’s getting more interesting. Since the MSCI Global index returns an annualised return of around 10%, let us assume that the 5 average stocks performance matched the returns of the market in this ten years. Let us see what is the result.
Not bad at all. Over ten years, the annualised return is 9.89%. Capital doubled at the 8th year mark. Just to share, my personal investment goal is to generate a 10% return annually.
Ways to improve returns over time
Selecting more profitable companies and less lousy companies.
As we reduce the number of underperforming companies and increase our performing ones, we will be able to positively influence the investment return over time. This can be done by doing more research into individual company or having a competent investment advisor to share his expertise with you if you do not have the time to do it. Alternatively, instead of buying individual stocks, you can use unit trusts to build your investment portfolio which is way much easier and less time consuming. More time can be spent with your loved ones or enjoying your hobbies. A lot of my weekends are burnt doing my own research, but i am not complaining as investing is my hobby and i enjoy researching on companies. It is very satisfying when you spot a good company and profit from it!
Not selling when market gets volatile
When the market get jittery, a lot of time, investors will get emotional and start selling their stocks. In which most of the time (based on my experience) regret doing so after the market rebounds. Selling during the down days are selling at a discount. Over time, we should be aiming to sell when the market is green and buy when the market is red. This ensures that we are always selling at a premium and buying at a discount. Over time, this advantage should be reflected in your investment return.
Don’t chase the market
Interestingly, investors tend to chase prices as well, similar to the point above. They get emotional and the FOMO triggers them to buy during the green days Again, investors should avoid getting their emotions involved while managing their investments.
Draft out an investment plan
When it comes to life events like marriage and having children, we always devise a plan for it. But when it comes to investment, many investors have none. When there is no plan, you end up being swung up and down by the market, many times taking profit too early and cutting losses that became mistakes down the road. A proper investment plan should include your time horizon, the amount of capital set aside for investment, etc. Sounds simple but you will be amazed to hear that a lot of investors have no idea about it. Usually, they will say, “just buy lor’, “I don’t know”, “see how”,etc. But without a plan, you cannot measure how your portfolio is performing against your investment objectives. It may also cause investors to take unnecessary risks.
Don’t take unnecessary risks/ Risk Management
Before someone even starts investing, they should at least understand their own risk profile. This ensures that you will not end up taking more risk than what is necessary to achieve your investments target and loss sleep over it. Risk profile is very personal and depends on factors like age, years to retirement, life stages, and so on. Just to use an example to illustrate. Assuming one investor is already retired and current age is 65. He is conservative and do not want to take much risk. He hope to get a 2% annualised return on his savings. Knowing this, we can roughly gauge his risk profile. He should not be buying stocks in view of his risk profiling and investment objectives. He could have gotten a 2% return annually just by buying investment-grade bonds. Therefore, avoiding instruments that are not suitable. Some people ask whether bonds or equities are better. I even heard someone on youtube commenting that options are better than stocks! But the answer is, there is no one financial instrument that is superior over other instruments. Each of these instruments has their own purpose. They can be used singly or a combination of them to serve the needs of an investor, according to his or her investment plan and objective.
Each financial instrument (Equities, Bonds, Mutual Funds, Options, Future, Forwards, Swaps) has their own purpose. I like to use knives to illustrate this. Can I use a carving knife to chop ribs? Or can i use a chopper to carve a watermelon? The answer is no for both questions definitely. But can i say that the chopper or the carving knife is superior? No, as both of them serve a different purpose. But what do they have in common? You will be hurt if you uses them incorrectly!
Similarly, before you buy something, you will need to understand it and avoid something that you don’t know, even though the product or instrument is very “hot” in the market. One good example is cryptocurrencies. I have avoided investing in cryptocurrencies over the years though i first came across bitcoin in the mid 2000s. Sometimes, i will ask myself, what if i have invested in bitcoin then… i will be filthy rich by now isn’t it. I am a human being after all. But i will quickly get back to my investment principles and avoid getting emotional about it. This is hindsight and of course, the price of bitcoin can go the other way too, which will then make me poorer. I admit that i have not done much homework on cryptoes and most probably, will not be doing it in the future. I would rather invest in something that i am familiar with or comfortable holding. That is my investment plan. But there is a way to solve this issue which will bring me to my next point.
Asset Allocation/ Portfolio Sizing
I could have invested in Bitcoin then, though i have always advocated that investors should not be investing in something that they do not understand. How? You may ask. By employing asset allocation. I could have allocated a small proportion of my capital then to bitcoin, an amount that i am comfortable with. In this way, I am managing the risks of my investment portfolio and limiting my losses on a particular position.
For example, i could have allocated a 1% weightage to bitcoin then as I am willing and comfortable to take a 100% loss on this 1% position. I can recover the losses easily with the other 99% of my portfolio.
Asset allocation is part of an investment plan. So we can see that without proper planning, we run the risk of missing out on a profitable trade. We may unknowingly increase our portfolio risk as well by taking a position that is too heavy.
Conclusion
It pays to have a plan when it comes to investing. Knowing and understanding the various points like individual risk profile, investment objectives, etc, will put us in a better position and ensures profitability of our investments over the long run.
Speak to a qualified, competent, experienced and licenced investment advisor to work out your investment plan today.
I hope readers will find this article informative.
If you have any questions or like to get in touch with me, do feel free to fill up the form below and i will try my best to get back to you as soon as possible. For the record, i am a full-time investor and a part-time investment advisor. A big bulk of my personal income comes from my own investment. I started my investment journey back in 1997 when the Asian Financial Crisis happened.