The Laziest Way of Investing
It is no different from driving a car without first learning how to do so. Yet there is a way to make stock investing safer and easier.
Question: I have started to invest in the stock market after hearing that it is a place where money can be made to grow in a big way easily. Unfortunately, it was not as easy as I thought. Right now, the combined value of the stocks I have bought are still below my cost. Is there a way to recover my losses quickly so that I can get out and just put my money in safer investments?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook.
Answer: Please allow me to comment on your perceptions about investing in stocks. It would be best to have facial tissue ready beside you as this discussion might cause your nose to bleed.
Kidding aside, you are right in saying that with stocks, you can make your money grow in a big way. If you had bought Universal Robina Corp. or URC at the end of October 2008, you would have shelled out only P5.20 a share. As of Nov. 20, 2015, the price of the stock was P198.00 a share. If you had sold your holdings last Nov. 20, 2015, you would have made an absolute return of 3,708 percent. This translates to an annual compounded return of 67 percent.
However, the investment would not have been easy. Luck is not part of investing. It would not have been a situation where you just happened to buy URC for no reason at all. You would have needed to study the operations of the underlying company that the stock URC represented. And even if you had by chance merely “stumbled” upon URC as an investment outlet, you would have probably sold it much earlier if you had no convictions about the long-term earnings prospects of the company that could only have come from solid research.
You are therefore correct in implying that investing in stocks is not a safe thing. Why, some people even call stock investing gambling. But in my book, investing in stocks is gambling only when you get into it without knowing what you are doing. It is no different from driving a car without first learning how to do so. Yet there is a way to make stock investing safer and easier.
Modern portfolio theory or MPT says that based on the efficient market hypothesis where information is instantly reflected in the prices of stocks, nobody can make above normal profits consistently. The capital asset pricing model or CAPM also says that there is only one risk to consider and that is systematic risk, the risk that affects all stocks. You should forget about those risks that affect individual companies as they do not matter. Combined, these two ideas imply that no one can beat the returns of the stock market as a whole, the returns for which are represented by the returns of the broad market composite index like the Dow Jones Industrial Average or S&P 500. Therefore, the conclusion is simply to buy index funds or create your own portfolio that mimics the composition of the broad market index. This is also called the lazy way to invest.
Unfortunately, you are invested in a stock market where information is not readily reflected in prices. More importantly, the Philippine stock market, as represented by the Philippine Stock Exchange Composite Index or PSEi, was in a long, volatile sideways movement from 1987 to 2008.
And while the PSEi began a long bull run from 2008 onward, that run was still characterized by wild fluctuations.
Based on the data from the Philippine Stock Exchange, the average annual returns of the PSEi from 1987 to (Nov. 20) 2015 was 14.3 percent with a standard deviation of 41. That means that given a normal curve, 68 percent of the time, the annual average return of the PSEi would have fallen within minus 26.7 percent (14.3 percent minus 41 percentage points) to 55.3 percent (14.3 percent plus 41 percentage points).
Given the foregoing data, index investing would have gone through very rough waters. To the novice investor, such a wide volatility would be scary. To the professional fund manager engaging in trading or the quick buying and selling of stocks, such volatility would be “delicious” as money can be made even with stock prices moving down, up or sideways.
So what strategy should you espouse in a stock market like ours? If you are a retail investor who does not have the expertise to analyze/trade the companies listed on the stock exchange, and does not have the capability to manage his investments full time, just do Peso Cost Averaging or PCA on a non-index fund, which presumably will do the trading for you. This is the easiest and laziest way of investing.
Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines. He is best selling book author of Pwede Na! (A Complete Guide to Personal Finance) in 2004, and is the chairman and president of the Personal Finance Advisers Philippines Corporation.
Source: http://business.inquirer.net/203119/the-laziest-way-of-investing
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