Needle In a Haystack
“Don’t look for the needle in the haystack. Just buy the haystack!” –John Bogle, Founder of Vanguard
Have you been looking for a needle in a haystack? Frantically searching for that one special stock or strategy that will finally make you rich?
Well, you're not alone. Millions of professional and amateur investors around the world have been doing that for as long as the stock market has existed. In response, a whole industry has sprouted up to feed those desires, claiming to hold secrets on beating the market which they would be happy to share... for a fee.
However, those so-called secrets rarely provide what they promise. Despite great claims of past success, some are highly dependent on luck and being in the right place at the right time. Others are so bogged down with conditions and fees that you might end up worse-off following them. Simply put, there is no free lunch!
We are about halfway through 2019. Already, many of the forecasts made at the beginning of the year are looking shaky. If you had heeded the warnings of recession and stayed in cash, hoping to invest only after the recession hit, you might be wringing your hands in regret; despite the recent market volatility from trade-war rhetoric between the US and China, global stocks have actually risen over 12% since the start of the year.
Every year, we see the same thing happening. In 2018, JP Morgan's list of best investing ideas included Facebook, General Motors and Deer. The three stocks are down by 20%, 10% and 6% respectively. Merrill Lynch's best picks of Blackrock, DowDuPont and Texas Instruments likewise lost 20%, 17% and 8% respectively. In contrast, the more diversified S&P 500 index experienced an overall small gain of 3%.
The local investing scene fared no better. Some of the stocks highlighted by the renowned The Edge Singapore in 2018 included City Developments, IFS Capital and Mindchamps, all of which suffered double digit declines last year.
For sure, some of the ideas put out by the media were actually great: Amazon rose 40%, Twitter by 33% and Verizon by 16%. But surely, such calls should be the norm and not the exception from financial institutions whose primary job is to identify the companies that will make money. If they can't do it, despite their ranks of experts, cutting-edge computing technology and the wealth of resources at their disposal, what hope do the rest of us have?
Following these investing recommendations can be fun. After all, it's always exciting and a great conversation starter if you get lucky and end up hitting it big. But you should never depend on such a strategy to fund your children's education or your retirement, for the same reason you shouldn't plan to fund those things by winning the lottery.
To expand the initial analogy of the needle in the haystack, stock picking in this way would be akin to buying individual sticks of hay and hoping that one of them is a needle. Common sense will tell you how silly that is. Most of the time, it will simply be a waste of money. Surely there must be a better way. How about buying the entire haystack? That is the only sure-fire way to get the needle, and here is how you can do it in a cost-effective manner:
Diversification
Diversification isn't a matter of holding just 10, 30 or even 100 stocks, which many investors consider sufficient. We're talking tens of thousands of stocks spread over countries, sectors, regions and asset classes (stocks, bonds, commodities, property, cash). This way, you get to still share in the good stock market performance of some markets even when others are not doing as well.
Asset Allocation
It's also important to take note of how the diversified components of your portfolio work together when combined. You don't want to be holding seemingly different asset classes only to have all of them collapse at the same time, which happens far too often.
This is especially common when investors are sold flavour of the month investments from brokers and banks, which may follow a theme and result in over-concentration in a particular area of the market – like Asian small companies, Emerging markets, technology or biotech.
Risk
Returns shouldn't be the only consideration; in fact, risk is more important. When you look at your portfolio, ask yourself: "Do I know how much money I could lose from this?" If your answer is "No," then you need to ask the right questions and not invest until you get the answer.
Use the Dimensions of Return
Not all haystacks are created equal. While having a well-diversified portfolio is a good start, you can increase your chances of success by determining that diversification in line with the dimensions of return.
These dimensions have been identified by financial scientists as persistent and pervasive, and are the natural outcome of market logic. They include:
investing in the stock market over holding cash or bonds
investing in smaller companies relative to larger ones
investing in more profitable firms compared to less profitable ones.
Essentially, what this means is that there is a scientifically-verifiable way to identify the haystacks with the most needles!
Contrary to popular perception, the point of investing is not to make as much money as you can or even just to make your money work harder. All investing comes with risk that should not be undertaken for no reason.
The main point of investing is to help you meet your future financial needs. Realigning your focus accordingly can take a lot of the stress out of the investing process, not least because you now have a concrete goal to work towards instead of just getting rich. In practice, this approach may mean choosing an investment with a lower but sufficient return over a riskier product with a higher return that would be nice to have but that you don't actually need.
Don't make things more complicated or take more risk than is absolutely necessary. Just make sure you plan well and invest according to these simple principles, for that's the only way to definitely get that needle!
