Why you should worry when politicians say everything is OK
On August 14, 1998 Russian president Boris Yeltsin declared – very definitively – that Russia’s currency would not be devalued. (YouTube clip here.) What> READ MORE
On August 14, 1998 Russian president Boris Yeltsin declared – very definitively – that Russia’s currency would not be devalued. (YouTube clip here.) What> READ MORE
One single investment strategy has probably made more people rich than all others combined. It’s a foundation of saving… yet it’s something that investors often> READ MORE
Finding great stocks to buy doesn’t do you any good if you don’t have any money to invest. And the best way to ensure that you have money is to not lose the money> READ MORE
There are a lot of stock brokers, and stock analysts, who are smart, hard-working people who want to make money for their customers. But that doesn’t mean that they> READ MORE
It was only after staring at 70 stock positions I knew nothing about that I understood that I was, right then, buying those positions every day. Eight years ago, I> READ MORE
On August 14, 1998 Russian president Boris Yeltsin declared – very definitively – that Russia’s currency would not be devalued. (YouTube clip here.) What happened three days later is a lesson for anyone who believes politicians when they talk about bad things not happening.
In an article called “Here’s Everything That Could Go Wrong in 2016,” news service Bloomberg warned that “Investors can’t ignore… so-called Black Swan scenarios following a year that surprised the world with record refugee flows and brutal terror attacks.”
There’s a lot of uncertainty in markets right now – particularly as the U.S. Federal Reserve is about to raise interest rates. And in a related article, Bloomberg lists some things that could cause different kinds of uncertainty. “Oil prices soar after Islamic State destroys facilities across the Middle East. Angela Merkel is forced to resign, throwing the European Union into disarray. The dollar slumps as Russian and Iranian hackers team up to launch cyber-attacks on U.S. banks.”
Some of these might happen. Most probably won’t. But you’ll know that something is close to happening when a politician announces that, no matter what, a very specific bad thing is not going to happen.
For example… three days after Boris Yeltsin’s declaration, the Russian currency collapsed 2.4% against the dollar. And it continued falling…
The People’s Bank of China (PBOC) provided a more recent, if less extreme, example. As we wrote recently (here), on November 30, the International Monetary Fund announced it would add China’s currency, the renminbi, to its Special Drawing Right (SDR), a basket of the world’s four most liquid and freely traded international currencies. This is an important step in the renminbi becoming a currency that’s not as tightly controlled by the government.
On December 1, the Wall Street Journal reported, “The People’s Bank of China pledged again on Tuesday to keep the yuan largely stable… The comments were aimed at allaying any concerns that, with the IMF decision behind it, China would now feel free to devalue the yuan—the base unit of the currency known as the renminbi—to help spur growth.”
“In terms of whether the renminbi will depreciate after its inclusion in SDR, there is no need for such a worry,” Yi Gang a deputy governor at the PBOC, said at a news conference.”
Since the PBOC’s pledge, and Yi Gang’s promise, the yuan has depreciated 1%. That might not sound like much – but for the yuan, it’s a huge move. And it’s only the beginning according to Jim Rogers and a lot of other people.
So, when a politician tries to assure people that something bad is not going to happen… get ready for it to happen.
One single investment strategy has probably made more people rich than all others combined. It’s a foundation of saving… yet it’s something that investors often ignore.
This magic is the power of compounding. It works by investing a sum of money that generates a steady return. But instead of taking that return and spending it, you reinvest it by buying more of the original investment. The next year both the original investment and the reinvested interest will earn interest, which you again reinvest.
With compounding, your original investment is growing in size due to repeated reinvestment, and every year you are getting a larger and larger sum of interest. It’s like a snowball rolling downhill, growing bigger in size as it picks up more snow on the way.
Let’s say an investor puts S$10,000 in a deposit paying 5% interest annually.
At the end of the first year, he is paid S$500 interest. But instead of taking this interest out of his account, the investor reinvests the S$500 on the same terms.
At the end of the second year, the investor will receive interest of S$525 (5% on S$10,000 + 5% on S$500). This is also reinvested, and the invested amount grows to S$11,025.
At the end of the third year, the investor will receive S$551.25 in dividends. His investible amount has now grown to S$11,576.25. Note the similarity to the snowball… the money that is working for the investor is growing larger every year.
The amount of interest the investor receives every year is increasing due to the magical effect of compounding.
An additional S$25 might not sound like much at first. But the beauty of compounding is what happens over a long period of time. That S$10,000 compounded over 10 years, at 5% per year, grows to over S$16,000. Over 30 years, it grows to S$43,219. And remember: If each year you had withdrawn and spent the S$500 interest, instead of reinvested it, at the end of 10 years, and 30 years, you would still just have S$10,000.
The power of compounding is far greater with larger returns. At a 10% annual return, you’d have S$25,937 after 10 years, and S$174,494 after 30 years. That’s a lot more than double what you’d earn at a 5% rate or return, thanks to compounding.
Apart from finding a reliable way to earn a good rate of return, time is the single most important factor that contributes to the power of compounding. Regular savings that start early in life and continue uninterrupted over the investor’s lifetime generate higher returns compared to those starting later in life, or those that stop saving earlier.
Taxes and transaction fees will take a bit away from your return. But the magic of compounding will more than make up for it.
Finding great stocks to buy doesn’t do you any good if you don’t have any money to invest. And the best way to ensure that you have money is to not lose the money that you already have.
Every investor has bought a share that’s gone down – an idea that seemed good at the time but is now down 10%, 30%, 50% or more. You might tell yourself a loss isn’t a loss until you sell. And (you tell yourself), if you sell now, you’ll miss the rebound that will make up for everything.
No one likes to admit defeat. But in investing, it’s important to have a disciplined approach to selling your bad positions and losing the battle. Otherwise, you risk losing the war when a few bad stocks wipe you out altogether.
The secret to keeping your wealth is simple. As legendary investor Warren Buffett put it, “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”
The math of selling your losers before they turn into big losers shows why.
Let’s say you bought shares of Singapore Exchange-listed Noble Group (NOBL). The shares have traded as high as S$2.34 within the past five years but now trade at around S$0.39.
If you bought shares at, say S$2.00, you’re now sitting on an 80% loss. But that doesn’t mean the shares would have to move up 80% for you to break even. NOBL shares would have to move up over 400% just to get back to the S$2.00 level. That’s a very big move. And counting on a big move just to break even is a bad idea.
Even less severe share price drops still make it difficult to get back to break even. A 50% decline in your NOBL shares to the $1.00 level would mean that the share price would have to double just for you to make your money back. How often have you bought a stock that’s doubled?
The key to not losing money isn’t to wait for the rebound. The key to not losing money is to sell before you feel any need to wait for a rebound.
The best way to do this is to use a trailing stop.
A trailing stop means that you sell your shares at a pre-determined level below the present market price. This price level is adjusted if the share price moves up. That way, you know exactly how much you stand to gain (or lose) as long as you sell at your trailing stop level.
For example, if you bought shares of NOBL at S$2.00, you might set your trailing stop at 20% below that level, or S$1.60. In this case, as long as you stick to your trailing stop, you’ll protect yourself against far greater losses.
On the other hand, let’s say that NOBL shares rose to S$2.20. As the shares rose, you would continually adjust your trailing loss level to 20% below the market price. At S$2.20, your sell level would be S$1.76. If the shares rose to S$3.00, your trailing stop would stand at S$2.40.
One important point: make sure you don’t put a standing market order in at your trailing stop level. You don’t want to tell your broker when you’re going to sell. Make sure that you make it a mental level – not one that you tell your broker.
The key thing is to follow through. If your trailing stop is hit, you must sell – no ifs, ands or buts. You might lose the battle, but at least you won’t lose the war. And you’ll still have capital to trade another day.
There are a lot of stock brokers, and stock analysts, who are smart, hard-working people who want to make money for their customers. But that doesn’t mean that they give you good advice… or that you’ll make money by listening to them.
There’s an entire industry dedicated to telling you what stocks you should buy. The main job of thousands of stock analysts in Singapore and Hong Kong – not to mention London and New York and other financial centers around the world – is to tell investors what stocks are a “buy”. Then there are many more brokers whose sole job is to relay to customers the smart things their analysts told them.
Most analysts rate most stocks a “buy”. Truewealth Publishing ran a screen of 333 stocks listed in China, Hong Kong, Singapore, Philippines, Thailand and Malaysia that have a market capitalization of more than $3 billion, and which have more than 10 analysts covering the stock. Of these stocks, 7% of them were rated a “buy” by every single analyst that covers them. And 70% of these stocks were rated a “buy” by at least half of the analysts that cover them. That’s a lot of buying.
The table below shows some of the biggest stocks in the Asia Pacific region that have the most “buy” ratings from stock analysts. For example, 37 of the 43 (86%) analysts who cover Tencent rate the stock a buy. 21 of the 25 analysts who cover DBS Group rate the stock a buy. Siam Cement is called a buy by 85% of analysts who cover it.
Does that mean that you should buy nearly everything? Of course not. But why do stock analysts say that you should?
First… those stock recommendations are code. To you and me, if someone tells me to “hold” something (whether it’s a stock or a carton of milk or a sleeping baby), that means I don’t let it go (and that I don’t sell it). But is that what the broker wants you to do with that stock?
Even the regulators understand the game. “Clear sell ratings have grown rare,” says the Financial Industry Regulatory Authority (FINRA), a U.S. securities industry regulator. “Some firms no longer even use “Sell” or any word obviously like it; frequently, a “Hold” rating in effect means “Sell”.”
Be warned, therefore, that when a broker or research report recommends a “hold,” it really may be meaning “sell”.
Stock analysts at banks aren’t analyzing stocks for you and me. They’re hoping to hook the much bigger fish of the companies themselves – companies might need advice on mergers or acquisitions, or on raising new money. You get close to a company by saying nice things about them. But you don’t get close to a company by calling their stock a sell. And often, young analysts are hesitant to ask questions of senior personnel in a way that might be seen as disrespectful.
For example… during the late 1990s tech bubble, analysts on Wall Street put “buy” ratings on the stocks of dozens of internet and tech companies that were doomed. In private emails, some of the analysts ridiculed their prospects. At the same time, they were writing glowing reports about them, encouraging small investors to buy.
It’s not a surprise that those very companies were paying Wall Street billions of dollars in fees for stock offerings and other financing.
Some stock analysts, and banks, aren’t in the market for big corporate deals. But they want to make money by generating commissions from buying and selling shares for customers. A “buy” recommendation pushes someone to buy… but a “sell” recommendation makes a customer sell only if he happens to own that particular stock.
So small brokers that aren’t trying to play nice with big listed stocks also might not have your best interests in mind. A stock analyst at a small brokerage house who issues too many “sell” recommendations – which won’t generate much in commissions – might find himself out of a job.
But maybe the biggest reason that stock analysts and brokers call so many stocks a “buy” is that they’re afraid of going against the herd.
Stock analysts are like everyone else: They like to be accepted. They want to fit in. They don’t want to be blamed for being wrong. And you can’t really be blamed for being wrong if everyone else is wrong, too. So it’s a lot easier to call the flavor-of-the-day stock a “buy”… whether it’s Chinese stocks last August, or mortgage-related stocks in the U.S. in 2007 – just before the credit crash.
But you don’t make money by investing with the herd. The herd buys at the top… and sells at the bottom. When the herd is buying, who are they going to sell to? There won’t be any buyers left.
One sure sign that you’re part of the herd: If a government starts talking up the stock market. When Chinese stocks headed for the moon in the massive bull run that started in 2014, People.cn, a website run by the country’s state media proudly claimed on April 21, 2015 that it was “just the start of the bull market” because the market had “support from China’s grand development strategy and economic reforms.” Just four months later, by August 2015, the Chinese stock market had fallen 32%.
Anyone who sold – instead of bought – would have saved himself a lot of headache and money.
The next time the talking heads on TV… or the fancy stock report in your inbox… or your broker on the other end of the line… says “buy,” just ask yourself why.
It was only after staring at 70 stock positions I knew nothing about that I understood that I was, right then, buying those positions every day.
Eight years ago, I became the manager of a $100 million hedge fund. The fund had been around for three years. The portfolio manager I was taking over from had put together a broad portfolio of stocks, bonds, currencies and options from a dozen markets and twice as many countries. Each position — that is, every asset that the fund owned— had a history.
Each position had a story and a reason that it was there. It might have been because a stock was cheap, or the company’s management was fantastic, or a big dividend was coming up, or that it was an unloved and beaten up stock that was coming back into favor.
On my first day on the job, my boss told me, “I’d like you to look at every position in the portfolio. Learn the story and why it’s in the portfolio. And then ask yourself if you would buy it today, right now. Because by having it in the portfolio, that’s what you’re doing.”
At first I didn’t understand what he meant. A stock in the portfolio was a holding… so the portfolio was, well, holding it. It had already been bought at some point in the past. I told myself I wasn’t the person responsible for the stock “being bought” now — someone else already had.
But he was right. Every position was taking up capital — actual cash — of the fund. If that cash wasn’t being used for that position, it could be available to buy a different security. So, by holding a position I was really “buying” that position — each and every day that it was in my portfolio.
This also makes sense outside of a stock portfolio. Think of what you own — all of your assets — and ask yourself: “If I had the cash in my hand to buy this right now, instead of the thing itself (whether it’s a stock, a bond, a house, or a car), would I still buy it right now?”
Sometimes you don’t have a choice. You need a place to live, so dreaming of what you’d do with the cash you’d receive from selling your house right now might be just a dream. And your old car might not be worth much, and you can’t compare its current value to what you bought it for when it was new.
But you may own other assets that, if you could do it again, you wouldn’t buy. You might be able to get something that works better, you like more, suits your needs better, or something that’s just a color you prefer. In the case of stocks or bonds, you might be able to put the money towards a different stock that has better potential or that pays a better dividend. Every day that you’re holding onto a loser, you’re using valuable capital that you could put to better use. Each day you own that asset — boat or stock or wheelbarrow or ring — you’re using money to own it, money that you could use for another purpose.
That’s why every day you are “buying” something that you already own.
I learned the stories of the 70 securities in the portfolio. I wound up selling about half of them to free up capital to buy different assets that I felt good about “buying” every day.
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