There is a Singapore tradition of a huge Hongbao Toto Draw during the Chinese New Year season. This year, the draw is on 22th February 2019 for an eye-watering $12 million. You can already start to reserve bundled packs of tickets. Will you be buying a ticket?
I did so some years ago as part of an office pool. I wasn’t intending to, but my colleague (and fellow CFA charterholder!) issued the following opinion: “The Investment Team strongly recommends that you join the office pool for this draw with $10 each. Yes, the chances of winning $10 million are about 0.001%. However, the probability of you ever earning $10 million doing this job for the rest of your life is absolutely zero. Furthermore, in that 0.001% scenario in which those of us who participate do win, you will be left doing all our work while we go on a holiday. You have till lunchtime to avoid this fate.” Within minutes, the final holdouts – the Puritans and the intellectuals – walked over waving red pieces in surrender.
No surprises – we did not win anything.
Many investors are too fixated on picking the right stocks at the right time. Instead, they should be fixated on their total return after all fees. Investment costs matter and here’s why.
If we are honest with ourselves, even though we know the odds, we all feel that it makes sense to bet $10 in TOTO for the chance of $10+ million because the payoff is so large. Not mathematical sense, but instinctive sense. A windfall is the stuff of dreams and we all need a sliver of hope at times. Screw probabilities. If I win, the realised odds for me are 100%. Before anyone thinks this is financial planning heresy, let me highlight that the operative words are “$10” and “if”.
How much should you bet on a low probability “if” with a high payoff? The answer is small amounts and very occasionally. Please do not do a “regular savings plan” (RSP) of a few hundred dollars every month into Singapore Pools. Instead, RSP into a “bet” that gives you a high probability of positive albeit non-outsized returns, as the core of your personal finances.
Where do we find a high probability of acceptable returns? In market-based investment portfolios held into the long term. Global public equities as an asset class have rewarded those who bet on it and stayed invested. Consider the S&P500, the US stock market, which is a big component of global market indices. If you had at least 15 years to not take out your money, it did not matter which year from 1928 onwards that you started investing: you would not have had a negative annualised return. In other words, despite the hell and high water of the Great Depression, dot.com bubble and the Global Financial Crisis markets recovered and you would not have lost money. If you excluded these events, the time frame for no negative annualised returns is shortened to 8 years. And in the “median” scenario (when you are neither that lucky or that unlucky), we are projecting the gross average annualised return for global equities including developed and emerging market equities, to be in the 7% region. It is not a huge windfall such that you will get into the front page of the papers, but the power of compounding returns can help fund your goals and beat inflation.
Many of us have this time horizon. Contrary to common wisdom, even retirees in their 50s or 60s should have at least some equities in their portfolio, as part of their spending will only be much later on, given life expectancies nowadays of 85 or longer. If your time frame is shorter, adding bonds to the portfolio will help to safeguard the odds, albeit at lower return rates.
Are you investing or gambling? Watch this video to understand what’s the difference.
So buy that lottery ticket, but only with spare change and once in a while. It is a fringe activity.
But where the odds are in your favour – make that the core. Make it a habit, invest regularly every month and stay the course into the long term.
In addition, consider adopting an investment philosophy that also eschews low-probability bets. Seek mainly to capture market-based return and to keep costs low. Look out for advisory portfolios that are constituted by funds which do not bet on markets, regions, industries or individual stocks/bonds, but diversify globally; and which do not make macro forecasts to do tactical asset allocation (which have an especially poor record of turning out well) but focus on long-term asset class returns. Funds should be low cost because costs are the only certainty in any investment and they eat into the return. Put another way, keep it boring! But isn’t that what happens when a conflict-free adviser does not ask you to pay him to gamble with your money?
This is an original article written by Chuin Ting Weber, Chief Executive Officer and Chief Investment Officer of MoneyOwl, Providend’s associate company. Providend and MoneyOwl have a shared investment philosophy.
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