Category: General Investing

Psychological biases are the human tendency for us to make decisions in an illogical way. The concept was introduced by psychologists Daniel Kahneman, Paul Slovic, and Amos Tversky in the early 1970s. Kahneman later won a Nobel Prize for his work and went on to write the best-selling book Thinking, Fast and Slow.

In his book, Kahneman describes the “fast thinking” part of the brain as System 1. This way of thinking helps us make snap decisions, such as jumping away when we hear a loud noise.

Slower thinking, or System 2, is used to solve more complicated problems. Usually, Systems 1 and 2 work very well, but in some situations, System 1 may cause a person to jump to conclusions too quickly and lead to what we now know as psychological biases.

What is confirmation bias?

There are numerous psychological biases and one of the more common and well-known of them that affects us as investors is confirmation bias. Confirmation bias is our tendency to cherry-pick information that supports our existing beliefs.

It partly explains why two people with opposing views can come to very different conclusions when they see the same piece of information. It can also cause us to make bad investing decisions. Take the scenario below for an example.

A friend at a party whispers a hot investing tip to you. You get excited at the prospect of making money but realise that it is important to do your own research. When you reach home, you hastily search for more information. Unfortunately, because of your preconceived conception of the company, you unwittingly reject data that goes against your belief and only look for information that supports it. Thinking you did sufficient due diligence, you make your trade the next day.

This is a common phenomenon. You’ll be surprised how easy it is to interpret data and statistics to fit your preexisting view.  Shane Parish, in his Farnam Street blog, wrote:

“Confirmatory data is taken seriously, while disconfirming data is treated with scepticism.”

In his book, Six Thinking Hats, Edward De Bono wrote:

“There may be more danger in prejudices which are apparently founded in logic than in those which are acknowledged as emotions.”

Why do we suffer from confirmation bias?

If the above scenario sounds familiar, then you have suffered from confirmation bias.

There is an innate desire for us to want to have been right. In the book The Web of Belief, authors Willard V Quine and J.S Ullian wrote,

“The desire to be right and the desire to have been right are two desires, and the sooner we separate them the better off we are. The desire to be right is the thirst for truth. On all counts, both practical and theoretical, there is nothing but good to be said for it. The desire to have been right, on the other hand, is the pride that goeth before a fall. It stands in the way of our seeing we were wrong, and thus blocks the progress of our knowledge.”

Confirmation bias is so ingrained in our brains that knowing that we tend to suffer from confirmation bias is not enough. The act of seeking out other data is not the solution- the problem is not being open to an alternative view.

How do we overcome it?

The first thing we should do is to give ourselves time to make a decision. Giving ourselves time to conduct research, talk to people in the know, and look for a different point of view, can reduce the risk of confirmation bias. Darren Matthews wrote in an article:

“It seems logical to add time to making decisions, slowing things down. Time offers a perspective that brings with it the capacity to bring other steps into play.”

Second, actively search out opposing views. Find arguments that reject your initial view and dig into the other corner of the Internet. Further, be willing to change your opinion if you find sufficient evidence to do so. 

Third, acknowledge that changing our opinion can be extremely difficult. In The Little Book of Stupidity, Sia Mohajer wrote:

“Research has shown that attempts to “enlighten” believers can be either entirely useless or serve to bolster their current belief systems. This bolstering of belief is often referred to as entrenching. This is the idea that once you have invested mental energy into a habit or belief, you strongly reject any potential contradictory information.”

We, therefore, have to make a conscious effort to realise the challenge we face in changing our opinion.

Final words

“What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.”

Warren Buffett

Confirmation bias is part of our everyday life. It affects anything from our political views to our religious beliefs to our investing decisions.

The first step to overcoming confirmation bias is to acknowledge that it affects us. Only then can we take active steps to have safeguards to ensure that it does not negatively impact our lives – or in this case our investment returns.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

It’s only natural for us to believe that individual investors don’t stand a chance against professional investors. After all, the pros have access to research capabilities, analytical support, and technology that individuals don’t. 

But if you’re an individual investor, you can still beat professional investors at their game. The trick is part patience, and part something else.

Long term investing

In Board Games, Coffee Cans, and Investing, I shared investment manager Robert Kirby’s Coffee Can Portfolio article that was penned in the 1980s. Here’s what I wrote in my piece: 

“In The Coffee Can Portfolio, Kirby shared a personal experience he had with a female client of his in the 1950s. He had been working with this client for 10 years – during which he managed her investment portfolio, jumping in and out of stocks and lightening positions frequently – when her husband passed away suddenly. The client wanted Kirby to handle the stocks she had inherited from her deceased husband. Here’s what happened next, according to Kirby:

“When we received the list of assets, I was amused to find that he had secretly been piggy-backing our recommendations for his wife’s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.

Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.”

The revelation that buying and then patiently holding shares of great companies for the long-term had generated vastly superior returns as compared to more active buying-and-selling helped Kirby to form the basis for his Coffee Can Portfolio idea. He explained:

“The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. That coffee can involved no transaction costs, administrative costs, or any other costs. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.””

The twist

In his article, Kirby also shared how he would use the Coffee Can Portfolio concept to build an actual portfolio. His solution: (1) Select a group of 50 stocks with desirable investment-qualities, (2) buy them all in equal proportions, and then (3) simply hold the shares for a decade or more. Kirby’s reasoning that such a portfolio will do really well has two legs: 

“First, the most that could be lost in any one holding would be 2% of the fund. Second, the most that the portfolio could gain from any one holding would be unlimited.”

But here’s the twist. Kirby did not put his solution into action, even when he thought it was a brilliant idea. There were two big problems. First, Kirby thought that the hurdles involved with assembling a team of investment professionals who can excel in constructing a long-term portfolio is too high to overcome. Second, there was massive career risk for him. “Who is going to buy a product, the value of which will take 10 years to evaluate,” Kirby wrote. 

The latter problem holds the huge edge that individual investors have over professional investors: There is zero career risk. After all, you can’t fire ourselves, can you? This means that individual investors can use the best portfolio management idea they have.

Earlier, I said that the trick to beat professional investors at their game consists of part patience and part something else. The patience bit involves the necessity of investing for the long run. The something else refers to individual investors not having to face career risk.

Stacking the odds

I first came across Kirby’s The Coffee Can Portfolio article a few years ago. I remember I was stunned to learn that Kirby was unable to act on a great investing strategy due to something (the career risk) that was not at all related to the effectiveness of the strategy. Individual investors have the luxury of not having to worry about this.

It is true that professional investors have a certain edge over individual investors in parts of the investing game. But not all hope is lost. Being able to invest for the long-term – a wise investing strategy, I should add – without career risk is a huge advantage that individual investors have over the pros.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

David Gardner is the co-founder of The Motley Fool, and he’s one of the best stock market investors I know. 

There’s a fascinating short story involving David that can be found in a 2016 Fool.com article written by Morgan Housel titled Two Short Stories to Put Successful Investing Into Context.

In the article, Morgan shared a conversation he had with David. Once, Morgan spotted David playing video games at the Fool’s office and asked him in jest: “If you had to give up board games, video games, or stocks, which would you quit?” (For context, David is a huge fan of board games.)

David’s response surprised Morgan: He would choose to quit stocks rather than board games or video games. Here’s Morgan recounting David’s brilliant explanation in Two Short Stories to Put Successful Investing Into Context: 

“Games are hands-on by design. They are meant to be played, not left alone.

But a good portfolio can prosper for decades with minimal intervention. A basket of stocks is not a board game with turns and rounds. It’s something that should be mostly hands-off. After a proper allocation is set up, one of the biggest strengths of individual investors is what they don’t do. They don’t trade. They don’t fiddle. They don’t require daily monitoring. They let businesses earn profit and accrue to shareholders in uneven ways. 

David’s point was that he could be happy never touching his investments again, because he currently owns a big, diverse set of companies whose long-term future he’s bullish on.”

David’s response echoes one of my favourite investing articles, The Coffee Can Portfolio, written by investment manager Robert G. Kirby in the 1980s.

In The Coffee Can Portfolio, Kirby shared a personal experience he had with a female client of his in the 1950s. He had been working with this client for 10 years – during which he managed her investment portfolio, jumping in and out of stocks and lightening positions frequently – when her husband passed away suddenly. The client wanted Kirby to handle the stocks she had inherited from her deceased husband. Here’s what happened next, according to Kirby:

“When we received the list of assets, I was amused to find that he had secretly been piggy-backing our recommendations for his wife’s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.

Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.”

The revelation that buying and then patiently holding shares of great companies for the long-term had generated vastly superior returns as compared to more active buying-and-selling helped Kirby to form the basis for his Coffee Can Portfolio idea. He explained:

“The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. That coffee can involved no transaction costs, administrative costs, or any other costs. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.”

Doing nothing is one of the most important actions we can take as stock market investors, and it has served me immensely well. It is also one of the hardest things to do. But I hope those of you reading this article can achieve this. Don’t just do something – sit there!

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

One of the best returns – maybe even the best – that Warren Buffett has enjoyed came from his 1973 investment in shares of The Washington Post Company (WPC), which is now known as Graham Holdings Company. Back then, it was the publisher of the influential US-based newspaper, The Washington Post. 

Buffett did not invest much in WPC. He controls Berkshire Hathaway and in 1973, he exchanged just US$11 million of Berkshire’s cash for WPC shares. But by the end of 2007, Buffett’s stake in WPC had swelled to nearly US$1.4 billion. That’s a gain of over 10,000%.  

There are two fascinating facts behind Buffett’s big win with the newspaper publisher. 

First, WPC’s share price fell by more than 20% shortly after Buffett invested, and then stayed there for three years.

Second, WPC was a great bargain in plain sight when Buffett started buying shares. In Berkshire’s 1985 shareholders’ letter, Buffett wrote:

“We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise. Calculating the price/value ratio required no unusual insights. Most security analysts, media brokers, and media executives would have estimated WPC’s intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market valuation was published daily for all to see.

Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.”

How many investors do you think have the patience to hold on through three years of losses? Buffett did, and he was well rewarded. Patience is the key to successful investing. It is necessary, even if you have purchased shares of the best company at a firesale-bargain price.

Warren Buffett has investing acumen that many of us do not have. But there are also times when common sense and patience is more important than acumen in making a great investment. Buffett himself said that no special insight was needed to value WPC back in 1973. What was needed to earn a smashing return with the company was the right attitude and patience.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Share price appreciation and dividends are the primary drivers of returns for shareholders.

In an earlier article, I discussed how stock prices are a function of future cash flows to the investor. In much the same light, investors sometimes value stocks based on multiples to earnings or revenue. This is because revenue and earnings is what ultimately drives cash flow to shareholders.

In this article, I discuss how business fundamentals and valuation growth may drive capital appreciation.

The two key factors

The equation below shows the relationship between share price appreciation, valuation, and a company’s growth.

Share price appreciation = Earnings/revenue growth X Price-to-earnings/revenue multiple expansion

Put simply, a company’s share price is driven by earnings/revenue growth and changes in the price-to-earnings/revenue multiple.

Increases in the price-to-revenue/earnings multiples are usually driven by a better outlook, new information, or market participants appreciating a company’s future prospects.

How to use this information?

As investors, knowing how stock prices rise can help us to pick stocks.

The sweet spot is to find a company that will grow its earnings/revenue and is also likely to experience valuation-multiple growth. 

But companies that can grow revenue/earnings at a quick pace without a valuation multiple expansion can still serve investors very well. For example, a company that is growing earnings at 20% per year, and does not experience a valuation compression, will give shareholders capital appreciation of 20% per year.

Too often, investors focus on the second part of the equation, hoping that valuation-multiple expansion can drive stock price appreciation, without taking into account that business performance also drives stock price performance.

In fact, even if there is a valuation compression, a company can still be a good investment if revenue or profit grows faster than the valuation squeeze. To illustrate this, I came out with a simple example. Let’s assume Company ABC grows revenue at 70% per year but is expensively priced at 60-times sales. 

The table illustrates what happens to ABC’s share price if there is a valuation compression each year.

As you can see, ABC’s share price grew a decent 25% per year despite the price-to-sales multiple dropping from 60 to 30. The above example can give us perspective on what we are experiencing in today’s investing environment.

There are numerous technology companies that are growing at a triple or high double-digit pace, and are expected to grow at these rates for the next few years At the same time, their price-to-revenue multiples are so high that is it likely the multiple will fall over the years. But if the top-line can grow faster than the contraction in the valuation multiple, we will still see the shareholders of these companies be handsomely rewarded.

Risks to growth

Before you invest in any richly-priced stock, you must know that high valuation multiples also pose a risk. If a company cannot grow revenues or profits as fast as its valuation contracts, its stock price may fall off a cliff. 

As such, investors need to be mindful that a rich valuation also comes at a cost. Valuation contraction can be extremely painful for investors if the company does not live up to the kind of growth that the market is expecting of it.

Final words

Deep value investors tend to focus on the second part of the equation, hoping that the market will realise that a company’s valuation multiple is too low – when the market becomes aware of its folly, the valuation multiple could expand, which could lead to stock price growth.

But don’t underestimate the importance of the first part of the equation- business growth. This is ultimately the longer-term determinant of a company’s share price. Valuation multiples can only expand up to a certain point before the expansion becomes unsustainable, while business growth can continue for years. Business growth can lead to huge stock price appreciation and is to me, the best way to find multi-baggers over the long term.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

A few days ago, I published Investing is Hard. In the article, I shared two things: 

• One, snippets of the State of the Union Address that two former US presidents, Bill Clinton and Barack Obama, gave in January 2000 and January 2010, respectively.
• Two, the subsequent performance of US stocks after both speeches. Clinton’s speech was full of optimism but the US stock market did poorly in the subsequent decade; on the other hand, Obama’s bleak address was followed by a decade-plus of solid gains for US stocks.

Here’s the snippet from Clinton’s State of the Union Address: 

“We are fortunate to be alive at this moment in history. Never before has our nation enjoyed, at once, so much prosperity and social progress with so little internal crisis and so few external threats. Never before have we had such a blessed opportunity — and, therefore, such a profound obligation — to build the more perfect union of our founders’ dreams.

We begin the new century with over 20 million new jobs; the fastest economic growth in more than 30 years; the lowest unemployment rates in 30 years; the lowest poverty rates in 20 years; the lowest African-American and Hispanic unemployment rates on record; the first back-to-back budget surpluses in 42 years. And next month, America will achieve the longest period of economic growth in our entire history.

My fellow Americans, the state of our union is the strongest it has ever been.”

This is the S&P 500 from January 2000 to January 2010:

The snippet from Obama’s State of the Union Address is this:

“One in 10 Americans still cannot find work. Many businesses have shuttered. Home values have declined. Small towns and rural communities have been hit especially hard. And for those who’d already known poverty, life has become that much harder. This recession has also compounded the burdens that America’s families have been dealing with for decades — the burden of working harder and longer for less; of being unable to save enough to retire or help kids with college.” 

The chart below shows the S&P 500 from January 2010 to today:

I think that Investing is Hard highlights an important idea about stock market risk: The riskiest time to invest is when everyone thinks there’s no risk; conversely, it’s the safest time to invest when everyone thinks risk is at its highest.

But why is this so? We can turn to the ideas of the late economist, Hyman Minsky, who passed on in 1996. When he was alive, Minsky was not well-known. It was after the Great Financial Crisis of 2007-09 that his ideas flourished.

That’s because he had a framework for understanding why economies go through inevitable boom-bust cycles. According to Minsky, stability itself is destabilising. When an economy is stable and growing, people feel safe. And when people feel safe, they take on more risk, such as borrowing more. This leads to the system becoming fragile.

Minsky was talking about the economy, but his idea can be extended to stocks. If we assume that stocks are guaranteed to grow by 8% per year, the only logical result would be that people would keep paying up for stocks, until stocks become way too expensive to produce that return. Or people will invest in stocks in a risky manner, such as borrowing to invest. But there are no guarantees in the real world. Bad things happen. And if stocks are priced for perfection in a fragile system, emergence of bad news will lead to falling stock prices.

The world of investing is full of paradoxes. The important idea that risk is at its highest when the perception of risk is at its lowest is one such example.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

The ultimate goal of investing is simply to make money.

The art of picking good investments is complicated but it boils down to one key question: What is the future cash investors can generate from an asset today? If we invest in real estate, rental income and resale value will determine our investment returns. For bonds, the cash flow is derived from coupons and the redemption value at maturity. Similarly, when we buy a stock it gives us the right to earn a stream of dividends in the future.

Companies that don’t pay dividends

But what if a company does not pay dividends? A famous example is Warren Buffet’s Berkshire Hathaway, which has only paid a dividend once since Buffett took over in 1965. Why then would a shareholder buy such a company if he is not going to earn any dividends from it? 

The answer, though, still boils down to dividends. Shareholders believe that eventually, Berkshire will start paying them dividends. This, in turn, makes the company’s shares valuable so that it can then be sold to another investor.

I’ve drawn up a simple example to explain this.

Let’s assume Company ABC can earn $10 per share in year 1. From year 1 to year 10, it reinvests its entire profit and does not pay any dividend. During this time, it grows its profit by 30% per year. 

From year 11 to year 20, it pays out 50% of its profit and reinvests the other 50% and grows its profits by 15% per year.

Eventually, in year 21, the company has run out of ways to grow its profits and decides to payout 100% of its profits to shareholders. It is able to earn this level of profit till eternity.

The table below shows how the value of the company changes over time based on the discounted dividend model.

I used a discount rate of 10% to calculate the value of the future dividend stream to the shareholder. As you can see, even though the company did not pay out any dividends in year 1, its shares still had value due to the promise of future dividends starting from year 11. The company’s share price grew as we got closer to the dividend-paying years.

As a result, even though shareholders in the first 10 years did not earn a cent in dividends, they still made money through capital gains.

From this example, we see the value of the company grows as the discount rate for the future cash flow decreases the closer we get to the dividend-paying years.

In addition, a company’s market value can also rise if there is an unexpected increase in earnings that results in a higher potential dividend.

Final words

Investing is ultimately about the future cash flow an investment brings for the investor.

In the case of stocks, it all boil down to dividends. Even capital appreciation is driven by (1) growth in dividends and (2) the smaller discount we apply to future dividends as the dividend stream draws closer.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Near the start of every year, the President of the United States delivers the State of the Union Address. The speech is essentially a report card on how the US fared in the year that just passed and what lies ahead. It’s also a good gauge of the general sentiment of the US population on the country’s social, political, and economic future.

In one particular year, the then-US President said: 

“We are fortunate to be alive at this moment in history. Never before has our nation enjoyed, at once, so much prosperity and social progress with so little internal crisis and so few external threats. Never before have we had such a blessed opportunity — and, therefore, such a profound obligation — to build the more perfect union of our founders’ dreams.

We begin the new century with over 20 million new jobs; the fastest economic growth in more than 30 years; the lowest unemployment rates in 30 years; the lowest poverty rates in 20 years; the lowest African-American and Hispanic unemployment rates on record; the first back-to-back budget surpluses in 42 years. And next month, America will achieve the longest period of economic growth in our entire history.

My fellow Americans, the state of our union is the strongest it has ever been.”

In another particular year, the US President of the time commented:

“One in 10 Americans still cannot find work. Many businesses have shuttered. Home values have declined. Small towns and rural communities have been hit especially hard. And for those who’d already known poverty, life has become that much harder. This recession has also compounded the burdens that America’s families have been dealing with for decades — the burden of working harder and longer for less; of being unable to save enough to retire or help kids with college.”

What do you think happened to the US stock market after the first and second speeches? Take some time to think – and no Googling allowed! If you had to bet on whether US stocks rose or declined after each speech, how would you bet?

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Ready?

The first speech was delivered in January 2000, by Bill Clinton, near the peak of the dotcom bubble that saw US stocks – represented by the S&P 500 – fall by nearly half just a few years later. By the end of 2010, US stocks were lower than where they were when President Clinton gave his State of the Union Address.

The second speech was from President Barack Obama and was from January 2010. The US stock market bottomed out in March 2009 from the Great Financial Crisis. And from January 2010 to today, US stocks have been on an absolute tear, rising three-fold.

Investing is hard because the best time to invest can actually feel like the worst, while the worst time to invest can feel like the best time to do so. I’ve said before that I think “investing is only 5% finance and 95% everything else.” This 95% includes psychology and control of our emotions. But we humans are highly emotional creatures – and this is why investing is hard. The best antidote I currently have, is to be diversified geographically, and to invest regularly and – crucially – mechanically.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

From time to time, Jeremy and myself receive questions from readers that are along this line: “Will the stock market of [insert country] be like Japan’s? Compared to its peak in late 1989, the Nikkei 225 Index – a representation of Japanese stocks – is still 40% lower today.”

It’s a good question, because Japanese stocks have indeed given investors a horrible return since late 1989, a period of more than 30 years. But perspective is needed when you’re thinking if any country’s stock market will go through a similar run as Japan’s stock market did from 1989 to today. Here’s some data for you to better understand what Japanese stocks went through back then:

• Japanese stocks grew by 900% in US dollar terms in seven years from 1982 to 1989; that’s an annualised return of 39% per year.
• At their peak in late 1989, Japanese stocks carried a CAPE (cyclically-adjusted price-to-earnings) ratio of nearly 100; in comparison, the US stock market’s CAPE ratio was ‘only’ less than 50 during the infamous 1999/2000 dotcom bubble. The CAPE ratio is calculated by dividing a stock’s price with its inflation-adjusted 10-year-average earnings. Near the end of May 2020, Japanese stocks had a CAPE ratio of 19, while US stocks today have a CAPE ratio of 30.

The data above show clearly that Japanese stocks were in an epic bubble in late 1989. It is the bursting of the bubble that has caused the painful loss delivered by Japan’s stock market since then. 

If you’re worried about the potential for any country’s stock market to repeat the 1989-present run that Japanese stocks have had, then you should study the valuations of the country’s stock market. But you should note that there are two things that looking at valuations cannot do. 

First, valuations cannot tell you the future earnings growth of a country’s stock market. If the earnings of a country’s stocks collapse in the years ahead for whatever reason (natural catastrophe, disease outbreak, war, incompetent leadership etc.), even a low valuation could prove to be expensive. 

Second, valuations cannot protect you from short-term declines. What it can only do is to put the odds of success in your favour. In an earlier article, 21 Facts About The Wild World Of Finance and Investing, I shared the two charts below:

They show the returns of the S&P 500 from 1871 to 2013 against its starting valuation for holding periods of 1 year (the first chart) and 10 years (the second chart). You can see that the relationship between valuation and eventual return – the higher the valuation, the lower the return – becomes much tighter when the holding period lengthens. 

To end, I have another important takeaway from Japan’s experience: It’s important to diversify geographically. Global stocks have grown by around 5% per year in US dollar terms from 1989 to 2019, despite (1) the terrible performance of Japanese stocks in that period, and (2) Japan accounting for 45% of the global stock market by market capitalisation in early 1989.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. 

Just a glance at the price chart of a stock market index will tell you that stocks don’t go up in a straight line. Stocks go up in a zig-zag pattern, making peaks and troughs.

Wouldn’t it be wonderful if we could keep buying at troughs and selling at peaks? We’d all be extremely rich. But the reality is it’s impossible. Even the best investors will tell you that timing the market perfectly is a pipedream. Yet, time and again, I still hear novice investors who are trying to do exactly that.

“The market looks expensive now. Maybe I should wait for another day.”

This statement may seem innocuous and something that many investors are feeling now. It is also understandable. The S&P 500 in the US fell by more than 30% from 19 February 2020 to 23 March 2020, but has since recovered almost all of the losses. Meanwhile, COVID-19 cases continue to surge and lockdowns are still imposed in many parts of the world.

I’m not saying that I know for a fact that stocks will keep rising from here. However, trying to time the market over the long-term will likely do you more harm than good. According to asset management firm Franklin Templeton, missing just a few of the stock market’s best days will severely damage your returns:

Staying fully invested over the 20 years leading up to December 2019 would have given you a 6.06% total annual return. However, miss just the best 10 days and your return would fall to only 2.44% per year. Miss the best 20 days, and your return drops to a negligible 0.08%. Miss the 30 best days and you are looking at a -1.95% annual loss. That would be 20 wasted years of investing.

I can draw one simple conclusion from this: The risk of staying out of the market is huge. Because of this, I much prefer a way less risky, albeit boring, approach of staying invested. By doing this, I know that I will not risk missing out on the best trading days of the market.

Less stress

Timing the market is also extremely stressful. Even for investors who are able to get it right once in a while, do the extra returns justify the effort? You’ll need to constantly monitor the market, find opportunities to buy and sell and are likely to still end up messing things up (see above).

Imagine you sold your investments just before some of the best trading days occur and the index/stock you are investing in never goes back to where you sold it at. You’d have missed out on some gains.

And what would you do next? Would you be able to convince yourself to buy back in at a higher price than you sold? You will likely continue compounding your mistake by never investing again. That’s a big mistake as historically the stock market tends to keep making new highs.

Final words

Time is your greatest friend in investing. There will always be reasons not to invest in the market. 

The legendary investor Peter Lynch once said that “Wall Street makes its money on activity; you make your money on inactivity.” Investors who are tempted to time the market should remember these wise words.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.