Investment Myths Busted

[LenaHuat]

Hi MM
Thank you for your generous comments. But I am not being unnessarily humble. I saw every1's reading lists and I was stumped. More so when I read Ishak's list Honestly, I have not read any of them until I hopped on to wookup. Guessed I was :

[-dol-]

I am still awaiting the potential best-seller "Insights from an otiose housewife" by one L.

[kennynah]

Guessed I was :

ah lena : no worries.... this signboard will lead the way...

[LenaHuat]

Hi K
Ah.............I've got a free ride from this Bat Cave fire truck. It gave me a vantage advantage
And I suppose it was also self-help, the vantage of wisdom that comes with age.

[la papillion]

Posted this on my blog: http://bullythebear.blogspot.com/2008/0 ... art-2.html

It's a little heavy on data.

-----------------------------------------------

Was nudged by millionairemind to do a little investigation into the total returns of STI should year 2008 fall by 20%. Since I have not been checking STI absolute value (I did check the daily relative % drop/rise though), I was quite surprised that since the start of the year, we've dropped a cool 20%.

I did post a table with the values of all the CAGR for different years from investing in STI, in this post. I think this time, I better list down my assumptions for calculating the values:


1. Most importantly, the data is taken from Yahoo! finance website. The price is adjusted closing price.


2. The CAGR (compound annual growth rate) is calculated like this:

To find the CAGR from period A to period B:

CAGR = (price at 31-dec of period B / price at 1st-jan of period A)^(1/(B-A)) - 1

If market is not opened on 31st Dec or 1st Jan, the price of the market days closest to the dates will be taken instead.


3. The AVERAGE CAGR is calculated by taking a simple average of all the CAGR of the same period i.e. sum of all CAGR of the same period divided by the number of CAGR taken.


Below is the table calculated for the returns on STI for different periods, assuming that 2008 closed on 31st Dec at 2769, a 20% drop from 1st Jan 2008:


http://1.bp.blogspot.com/_3qF-4FCPF1I/S ... 19_STI.gif

For comparison, here is my earlier table posted, without taking into account 2008:


http://bp2.blogger.com/_3qF-4FCPF1I/SB6 ... 5_CAGR.gif

Here's what can be observed:

1. Average CAGR dropped across most periods. 'Most' is the keyword. Average CAGR for 5-yr, 7-yr, 10-yr actually increased. I don't ascribe any significance to this fact, because of the way I computed the CAGR. I took 1st Jan and 31st Dec as the price for each period of calculation, so I'm very sure that if I changed the starting and ending period to take the price (say, using 1st June to 1st-June next year), the whole data will change.

2. Adding data for 2008 still doesn't change the fact that after investing for 14-yrs, there is not a single year of negative CAGR. This means that based on historical data, if one invests in any year in the past, for 14 years starting from 1st Jan and selling on 31st Dec of the 14th year, you will not make any losses. But the returns are a pathetic 3.1% per annum (on average) for a period of 14 yrs.

Again, this would most definitely change should I change the dates where I calculate my CAGR for different periods.

3. This much I can conclude: Investment period and Average CAGR seem to follow a U-shaped curve. There is a period of declining average CAGR from 1-st year till around the 10-14th year, beyond which, the average CAGR increases with period of years invested. However, the shorter the period of investments, the more volatile the the returns are. Conversely, the longer the period of investments, the less volatile the returns will be.

4. Here's a very interesting observation when I break down the percentage of getting positive CAGR for different investment periods.

------Years----total number of samples----number of +CAGR----------% of +CAGR
-------1 yr-----------------21---------------------12---------------------57%
-------3 yr-----------------19---------------------14---------------------74%
-------5 yr-----------------17----------------------12---------------------71%
-------7 yr-----------------15----------------------10---------------------67%
------10 yr----------------12-----------------------9----------------------75%
------12 yr----------------10-----------------------9----------------------90%
------13 yr-----------------9-----------------------8-----------------------89%
---14 yrs onwards---------------------------------------------------------100%

It's quite obvious that the longer the period of investments, the lesser the number of years in which one gets negative returns, no matter which year they started the investment. As mentioned, on the 14th year onwards, all the sample data gave positive CAGR.

But all these mean nothing if the percentage of losses in sample data is greater than percentage of gains in sample data. What I mean is that even though, based on past data, there are greater chances of getting +ve returns no matter what investment periods I choose, I can still lose money if the % of losses in losing years are greater than the % of gains in winning years.

Let's see this table:

------Years----Average gains of +ve years^----Average losses of -ve years#
-------1 yr-----------------28.1%---------------------16.2%
-------3 yr-----------------12.3%---------------------10.3%
-------5 yr-----------------9.8%-----------------------5.2%
-------7 yr-----------------7.6%-----------------------3.8%
------10 yr-----------------4.4%-----------------------1.7%
------12 yr-----------------3.2%-----------------------0.3%
------13 yr-----------------3.3%-----------------------0.8%

* There are no data for 14th year of investment periods and beyond, because there are no -ve years.
^ average gains of +ve years means the simple average of all the gains made for that particular years of investment
# average gains of -ve years means the simple average of all the losses made for that particular years of investment

I am quite surprised by the results. Not only are there higher probability of getting positive years, the average gains for every data for different investment years yield the same results - the average gains of positive years is much more than losses incurred in negative years. But of course, average doesn't mean anything. On average, each family in country X has 2.2 children doesn't really mean they really have 2.2 children. The same logic applies here.

[millionairemind]

La pap,

Thanks for the analysis. Appreciate it.

The scary thing is if we started investing 12 years ago passively in index fund tracking STI. After 12 years (end 2008), our CAGR is only 1.9%. Go back 15 years and it is only 0.9% Not too different from putting it in FD...

Cheers,
mm

[la papillion]

That is true, mm.

But do note that we didn't include dividends received. If if we include dividends yields of 3-4% (I don't know the yields, seriously, just guessing. I do know 1H of STI gives 2% yield) per year, we'll get higher returns. Or rather 'market' returns.

Some sort of timing is required here for sure. If one buys in at peak of 2007...I think he/she can wait for a long long time to see reasonable returns.

[millionairemind]

Another article today in The Sunday Times that keeps harping on the same old tune, permeating investment myths to the general public

Actually traders should be thankful for this kind of articles cos' when market corrects, if everybody sells.. who is going to buy from them when they sell out and goes back to full cash

Aug 31, 2008, The Sunday Times
Why fear is a loser
Investors typically resort to panic selling during bad times. The Dalbar report explains why staying invested is critical to successful investing
By Lorna Tan

Investors are constantly reminded that staying invested is the key to successful investment. But when the values of their portfolios plummet due to poor-performing equity markets, fear invariably takes over and it becomes increasingly difficult to adhere to that advice. In fact, most investors go into a selling frenzy when markets decline. Investors who are experiencing that sinking feeling can take heart from the latest findings from US-based research firm Dalbar. The latter has been measuring the effects of investor decisions to buy, sell and switch into and out of funds since 1984. In its 2008 report, it examines real investor returns for funds of various asset classes for the 20 years ended Dec 31 last year.

Staying invested does pay off (????)
One key finding is that unit trust investors who hold their investments typically earn higher returns over time than those who time the market. Dalbar explains that retention is 'critical' to investment success because one cannot benefit from the market if one is not in the market. This is because though it is beneficial to avoid market downturns, very few investors actually do so consistently and successfully.

The key, says the report, is to remain invested to reap the benefits of any market gains. 'During the last 20 years, equity investors would have realised monthly gains 65 per cent of the time. In other words, their chances of making money would have been nearly seven in 10,' says the report.

Guessing it wrong
Using its Guess Right Ratio, Dalbar highlights the problem that investors face. It appears that most investors are able to make the right decision in a rising market but they are unable to guess the direction of the market correctly after a bear market.

These investors typically guess wrongly that the market would not recover - an assumption based on fear. As a result, they stayed on the sidelines as the market recovered. But the 'really smart decision', says Dalbar, is to invest when the market is down.

Its Guess Right Ratio measures how often the average equity investor correctly 'guesses' the direction of the market. Net mutual fund inflows and outflows are used to determine if investors made short-term gains by correctly anticipating the direction of the market. The average investor guesses right when there is either net inflow each month followed by a market rise or net outflow followed by a downturn.

An analysis of the 20-year period ended last Dec 31 shows that equity investors were more often right than wrong. However, the periods of incorrect guessing had an impact on their portfolios. Perhaps not surprisingly, the Guess Right Ratio was highest - at least 67 per cent or eight out of 12 months - during years when markets posted strong returns and, with few exceptions, lowest during market declines. The overall Guess Right Ratio for the 20-year period is 61 per cent.

This is why Ms Penny Lim, director at financial advisory firm FPA Financial, does not recommend that clients try to time the market by selling out and waiting to get back in later at a lower price.

'It will be risky to do so now, as you could end up being out of the market when it rebounds. Judging from the level of pessimism, the level of cash holdings, the upswing could come fast and steep too. You don't want to take the risk that you could be out of the market when it recovers,' she said.

Buy and holding period (never read our Investment Myths Busted section har??)
A contributing factor to the poor investor performance is the 'less-than-ideal' holding period, says the Dalbar report.

Its research shows that equity shareholders usually sell their holdings in less than four years. This implies that investors do not have the patience or emotional discipline to weather market dips. In fact, the current trend indicates that the average holding period for funds has deteriorated, no thanks to the US sub-prime mortgage crisis and subsequent economic downturn.

It is no wonder Dalbar finds that over the 20 years ended last December, the average equity fund investor would have earned just 4.48 per cent a year, compared with the S&P 500's annualised return of 11.8 per cent. This translates into an underperformance of more than 7 per cent a year.

Proper asset allocation
A tip on containing investor fear and avoiding market timing is to focus on risk control.

'Have an asset allocation that gives you a comfortable downside. If you can stomach 10 per cent annual loss, then find an allocation that gives you that,' said Mr Chris Firth, chief executive of wealth management firm dollarDex.

This is because you are less likely to panic when the inevitable bad period comes along.

Building a suitable asset allocation requires an understanding of your risk tolerance, time horizon and your required rate of return, said Mr Ben Fok, chief executive of Grandtag Financial Consultancy.

Still, it doesn't mean that investors can take a backseat and relax once a portfolio is set up. It should be reviewed at least quarterly.

Balancing your portfolio
Another piece of advice given by investment experts is to buy low, sell high, something which most investors would agree is easier said than done.

But if you are constantly rebalancing your portfolio, you are in effect already buying low and selling high, said Mr Fok.

Rebalancing is an effective means of bringing your portfolio back to your original asset allocation mix of stocks, bonds and cash. It is necessary because over time some of your investments might become 'out of alignment' with your investment goals.

For example, your initial asset allocation might have been 60 per cent equity, 30 per cent bonds and 10 per cent cash.

Due to the bullish stock market, your asset allocation changed to 80 per cent equity, 15 per cent bonds and 5 per cent cash. Accordingly, you should rebalance the portfolio to get back to the initial asset allocation.

You do this by selling 20 per cent equity and buying an additional 15 per cent bonds and 5 per cent cash. Rebalancing requires you to sell assets that are performing well and buy assets that are currently out of favour.

By doing so, you'll ensure that your portfolio does not overemphasise one or more asset categories, and you would return your portfolio to a comfortable level of risk, added Mr Fok.

[Musicwhiz]

I read the article in the Sunday Times.

Suffice to say - It is misleading and an over-simplification. Investing is not so straightforward buy-and-hold. It requires a lot of reading, research and understanding, even when it comes to unit trusts (not just pure equities).

I won't go too much into highlighting the portions which are inaccurate, waste of saliva ! A lot has been said in this thread which should dispel the myths perpetuated in the article.

Sometimes I think the paper should be more responsible when writing articles like these. The whole country reads them leh !

[la papillion]

Haha, I read the papers too Thoughts of Investment mths busted thread comes to my mind