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Is studying hard the key to investment success?

An edited version of this article was published in the 13 October 2018 issue of TODAY Online.

Below is our original article in full.


Education Minister Ong Ye Kung recently announced the scrapping of mid-year examinations for Primary 3 and 5 pupils as well as for Secondary 1 and 3 students. Most of us remember sitting for an endless stream of exams with the understanding that the results from one single exam could determine our future. We studied hard so that we could snag that place in one of the coveted schools – believing that this was the first step to ensuring success in life.

Because of our ingrained exam and study culture, it is hardly surprising that many of us equate studying hard and doing well with most aspects of our life. After all, if we study hard, we will be able to get good jobs and hence be set up for life. Same with sports – train harder, and you will get the gold medal. Thus, is it surprising that we also apply the same approach to investing? If you know more about investing, and know when to trade and which stocks to trade, you can achieve investment success. In other words, the smarter you are, the better you will do. Or will you?

Unfortunately, this is where the argument breaks down. The sad reality is that working harder and being busier in investing does not necessarily translate to investment success. The truth about successful investing is that it is independent of your IQ or work ethic. Anyone can be successful in investing if they were to merely follow a few simple rules (see end of article).

The financial services industry is a magnet for many smart and capable people. All these brilliant individuals are hard at work every day trying to figure out what the best investment should be at any given time. However, the fundamental flaw in this method of investing is that nobody can predict the future. The vast amounts of time, money and effort that get spent on research can be rendered redundant by unforeseen economic, corporate or political events. The best researched investment bet can go awry in an instant.

Using 2016 as a case in point, the consensus was that oil prices would stay high and investments in oil-related companies would be a good call. This thesis was perfectly logical – the world was getting richer and consuming more resources, which resulted in higher energy needs. How could the price of oil possibly collapse? As we all now know, it did, and it was a downturn that many didn't see coming.

What about the current bull market? It is already one of the longest in history. Equity valuations are expensive and there hasn't seemed to be much growth happening that would continue to boost the profits of companies. Well-known investors and CEOs sounded the death knell for the market in 2016. It is now 2018, and we have yet to see a market collapse along the magnitude of 2008, which many had predicted. So, what happened? How can such ‘educated’ forecasts from respected investment professionals go wrong? (For the answer, you can refer to our earlier article - “Follies of Forecasting”, TODAY April 2017.)

Part of the answer is how the financial industry works. It is an open secret that the business model and compensation structure of the main players in the financial services industry is to get you to trade, and trade often. As such, these institutions have a vested interest in convincing you that the key to having a successful investment experience is by buying and selling your investments often, and preferably by also subscribing to their market calls, which change frequently and almost on a daily basis.

Thus, the business model is simple – each time you trade, you pay a fee (whether brokerage or otherwise) to the institutions for rendering you the service. You may think that you have negotiated cheap fees, but if you trade often, these fees can add up to a lot, which ultimately subtract from your returns. Institutions incentivise you further by giving you special client privileges if you trade often, like direct access to the dealer desk, lower trading fees, or exclusive invitations to special events.

This is all fine if all that trading leads to good investment returns in the long run, and paying fees is a legitimate compensation for services rendered. Yet, surprisingly to many, a buy-and-hold static portfolio works best for most investors. So, why isn’t this being promoted? The simple reason is that a banker who sells such an investment approach may not be able to generate sufficient revenue to meet his key performance indicators (KPIs). Hence, the industry is not incentivised to change the way they sell or operate.

Read any financial publication, or watch the entertaining financial news channels, and you would notice numerous ads for trading software, options trading courses, chart packs, news alerts, and other methods that purportedly give you an edge in investing. To be fair, a small segment of the population actually does enjoy keeping up with such technical analysis of stocks, or understanding fundamental analysis and getting bombarded by frequent changes in price trends over their smartphones. But, for the rest of us, we really do have more important things to do with our lives.

It may also be a surprise to many that investment success has absolutely no correlation with the level of your IQ or qualifications. In fact, smarter investors tend to do worse than average. In contrast, people who succeed don't really trade much. Instead, they concentrate on getting their asset allocation and underlying portfolio properly diversified – which helps them stomach market volatility when it happens (which it will!).

If you need more proof that assiduously keeping up with what happens in the markets won't help you outperform, one study humorously found out that the best performing investment accounts were from people who were either dead, or had forgotten that they had investments in the first place! In other words, investment success was most likely for accounts that were untouched and left to work on their own.

It is interesting to observe that many property investors are perfectly content to leave their properties alone to ride the cycles over many years, but have an incredibly short-term threshold when it comes to stock investments. One only wonders what will happen should the day come when the value of your property is quoted day by day for all and sundry to see!

The obsessive thought that one needs to be constantly trading or tinkering with one’s portfolio in reaction or in anticipation of market events, affects not only individual investors but also professionals who manage money on behalf of others. However, the big difference is that these busy managers are able to pass on their costs of trading, research and other costs for supposed outperformance back to the end investor.

In his book Contrarian Investing, author Anthony Gallea notes that, "Investing is a strange business; it's the only one we know of where the more expensive the products get, the more customers want to buy them." For example, one of the most expensive hedge funds in the world charges 5% in annual management fees and 44% in performance fees.

Perhaps investing is not the only industry which faces this. Rising consumerism has led to huge demand for luxury items, such as the Hermes Birkin bag, which can range in price from $10,000 retail to over a million at auctions and is only offered to their A-list clients (the legendary waitlist is apparently a ruse for Hermes opportunists!).

However, investors must realise that investment products are not luxury items, and investment returns are a zero-sum game. The higher the fees you pay (be it through trading, research or other costs), the lower returns you receive. This doesn't mean that all fees are bad. While this may sound a little self-serving, if the fees you pay to an adviser help you achieve peace of mind and get you a proper investment plan with a high probability of meeting your family's future financial needs, then shouldn't that be worth something? But if you can eliminate other costs that do not add value, such as frequent trading costs, then you increase your probability of investment success.

So, don't join the pack in seeking to be smarter than everyone else by studying hard about individual stocks, and trying to uncover the next Facebook. Because it is extremely difficult and the odds are against you. Instead, just remembering these simple guidelines will help you create a better investment experience:

  1. Let the capital markets (stock and bond) work for you, instead of trying to out-guess the market.
  2. Investing is not gambling. If it feels like gambling, you’re doing it wrong.
  3. Consider the factors that contribute to higher returns, and make them part of your portfolio.
  4. Practise diversification(having a portfolio made up solely of Singapore stocks is not proper diversification!) and don't keep actively trading around.
  5. Manage your emotions. Don’t let yourself be swayed by fear or greed into making impulsive decisions that you regret later. Get a good friend or trusted adviser to keep you grounded.
  6. Take a long-term view and let compounding work for you.
  7. Don't let scary headlines distract you. Focus on the big picture and what you had have set out to do.
  8. Focus on what you can control. You cannot control how the market will perform, but you can control how you react to it.

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