My Investment Strategy : 3 Ts 3 Ms ( part 1 )





Successful Investment in stock market is not just about luck or skills , it is combination of various factors as I mentioned above and it is not easy nor simple as people thought.  Successful investing also does not have any correlation with one’s intelligent.


Allow me to quote below from Warren Buffet :

“You don’t need to be a genius or rocket scientist to invest well. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”

As you may refer to my investment strategy or philosophy in the section of “ About Me “ … I have summarized the important of any investment success into 6 key elements as above .

These 6 factors will determine our success in investing and failure to achieve any one this will make us fail or unable to achieve our goal of financial independence.  Like wise , if we could get few of these elements especially “right “ , e.g Timing and Trade ,, it will lead us towards F.I ( Financial Independence ) much earlier than average .



In today’s blog post , I would like to elaborate two elements : Time and Timing.





Remember the famous quote from Benjamin Graham : “In the short run , the market is a voting machine . But in the long run, it is a weighing machine .”  In today’s context , stock market is like a Big giant casino , where traders and punters bet against each other in short term .  







Base on above chart , the market looks like “ casino’s Big vs Small “ with 50/50% chance on daily basis … but if we invest in much longer time horizon e.g over 20 years rolling time frame , our return will be 100 % in positive. That’s explained the quote from Benjamin Graham .

<Another 2 charts showing various returns by rolling holding period >








You may notice that in the long run ,, investing in share market is having much higher return than bonds , but most people still heavily invest in bonds which academic research call this as  “Equity Risk Premium (ERP)“ puzzle . 

Of course risk tolerant is the key factor for most of the investors to consider how many % of bond they should hold in their portfolio , but for younger investors , holding more bond should consider as more risky ? But , how much bond / cash to hold will also be determined by “market valuation “ at certain point of time ..ie “ Timing “ which I shall explain thereafter .

Compounding Effect : Over the TIME












"Time " is the key factors in making the " compounding effect " miracle.  Now look at below chart , the compounding impact will be much greater at the end of longer period … World Greatest investor , Warren Buffett got his first Billion at age of 56 but look at the subsequent  years on how the compounding effect kick in that make his multi billions empire .

































Stretch your investment horizon and let the “compounding effect “ take place eventually .



< Credit : Behavior Gap >



Compounding effect : Start earlier 


Let’s assume 2 investors A and B :

  A) Invest $10 K per year from year 1-10 and stop subsequently to let the money compounded each  year at 8% p.a. His total invested principal = $100,000.

 B) Invest $10 K at year 11th ( 10 years later than A) , for subsequent 25 years and at compound rate  of 8%  . His total  invested principal = $ 250,000.


At the end of years 35 , Just guess who will have more accumulated wealth , A or B ?


Surprisingly , is A) … Yes , just 10 years earlier and stop subsequently . Due to “ compounding effect “ , the amount accumulated is much higher than those start later .

Please refer to below chart :



<PS: Of course do note that such assumption might be too simplistic as the return might be different from year to year. End result might be different if both have achieved different rate of return in between. The chart is just to illustrate the ”start early " factors in compounding effect in any investment . >









Most of the investors feel that timing the market seems impossible and futile . Yes , indeed in the short run . Doing prediction of market movement looks like “ fortune telling “ it is hard but how about much longer term ? Will we be able to get some clues about market “valuation “ at particular points of time.

< Short term vs Long term >



According to conventional wisdom, any attempt to time the market is fundamentally flawed. Stock markets follow a ‘random walk’, they say. No one can predict the market’s next move, so trying to do so will end up costing you money. A lot of your long-term gains will come from a few big “up” days, and these are completely unpredictable — if you are out of the market when they happen you will miss out on a lot of profits.




This Book by Burton G. Malkiel explain the concept of Random Walk Theory in great detail : 




There is another school of thought who belief that market is non-random . They think that stocks movement is unpredictable in the short run . But if we stretch the prediction time horizon in a much longer period, at least to some degree of predictability is present in stocks based on a comparison between price behavior and other influence like earning , market valuation (PB) for example .

This book by Prof. Andrew W. Lo & A. Craig Mackinlay explain this concept in detail :







This is what " short term " and "long term " looks like in the eyes of Carl Richard in his book called : Behavior Gap. 














< Credit : Behavior Gap>


We can’t really see any pattern in short term but in the long run , the stock market activities is very much related to “economic value of the underlying business / demographic / technology enhancement etc .. Stock market tends to move in “upward “ direction in the long run.
















One may argue that we do not have such long time horizon in our investment life cycle . Yes, it is true , but please refer to my earlier blog post , we may try to take a look at the valuation of market at 20-30 years time frame and do a “ regression line “ , tr to do the “market timing” base on “market valuation vs long term "mean regression " .


Easy said than done , good valuation only appear when there is crisis . But during crisis , the “ fear factor “ will rule and our emotional ( another element in my 6 factors strategy ) will determine our success in such tough situation.  One will need the courage to punch the “buy “ button in such crisis time.


As I have repeatedly highlighted that volatility not equal to risk and there will be opportunities during crisis. " Risk " is not knowing what we are buying or investing in and subsequent lost of capital permanently.






“ Linear Regression and Mean Reverting “



< Monthly STI Index updated till 29 Jul 2016>

I am using this chart to judge the market valuation in long run and do the re-balancing of my portfolio from time to time, either moving more into equity or keeping more cash ( or buying short duration bond). This is quite similar to " Chan's Channel " developed by Dr Chan Yan Chong ( an Adjunct Prof at City University of Hong Kong ).

Base on this chart , market valuation seems not at "dirt cheap " or crisis level ,but also not over value since it is at below "regression mean " point. Statistically , there is still more than 50% chance to out-perform the market at current valuation , if we hold it for much longer time.  At green line level , the "odd" of winning will increase to approximate 68% ,, while the orange line will give one to have winning odd of more than 95%.

Remember that stock market is about " probability " not " certainty " .. as I have quoted in my previous post . Also , please take note that stock market could be in more " irrational mood " or moving sideways much longer time than we thought.  Therefore , holding 100% in cash and wait for the market to correct may not be wise in long run.

Please refer to below link for more detail :


How about you ? What is the factors you use to decide when to buy or re-balancing your portfolio ?

Please stay tuned for part 2 and part 3…

Cheers !





 “The four most dangerous words in investing are: ‘this time it’s different’.” John Templeton






Further reading on ideology of Mencius (孟子) on 《天时地利人和》:

< For Chinese from Baidu >


< For English from Wikipedia and The School of Mencius >









Comments

  1. Hi STE

    Your method on the linear regression and reversion to mean is great, simple and is very similar to the one by Dr Tee, except that he has those on individual stocks.

    ReplyDelete
    Replies
    1. Hi B,
      Yes, I hv seen his on his blog but never attended his class or courses ,, mine is more on methods same as Prof. Chan on his so call " Chan channel " ... But I guess all methods are quite similar in using regression line to work out the mean variance ,,
      I have plot some chart on individual account,, but for my own use ,,as I said earlier , I try to avoid mentioning any particular stocks to cause any confuse ,, may be I will try to share few in my future post as reference for discussion only ,,, reason I bought into HKG Land also party because it has fallen much below it's regression point ,,same for DBS in early year ,,,when price hit $13+ ,,, it is equal to about -1 Sd ,, which is quite rare ,, hence I also nimble on that ,,,few counters I noticed and nimble also,,when ARA having price dropped after right issue ,, also the GLP on fears so China economy ,, those are few I pick up in last mini panic in early Jan or Feb ,, Cheers ,,, I hope to share some of the chart ,, by not being hindsight biase ,,😃😃

      Delete
  2. Thanks a lot for sharing.

    In a way, I've also tried to do that method (though I never really plot the graph itself) by comparing against their 10 year records and for as long as fundamentals remain, it only means that anything on a -SD1 and -SD2 is a very good long term play.

    Hoping you to share on some of the counters next time, but for discussion only :)

    ReplyDelete
    Replies
    1. Hi B,
      Sure, I will share some of the charts in coming blog. .just for reference. ☺☺
      Yap! It is easy to draw such line for any counters so long as we could get the data from Yahoo Finance n using excel to plot it...☺☺👌👌cheers!

      Delete
  3. Hi STE,

    Using Chan's Channel on individual stock would need to exercise a lot more care. Some stocks may never recover if the fundamentals deteriorate or the industry the company operates in becomes less relevant eg Kodak, Nokia. If one has invested in Kodak for example, it never recover.

    ReplyDelete
    Replies
    1. Hi millionfaith,
      You are absolutely right ! Is tricky to use Chan channel for individual stock ,, still , the selection should base on Fundamental analysis, then using this chart to spot any price correction to more under-value level , e.g -1 SD or -2 SD ,, provided the fundamental of underlying business still sound and intact .. cheers

      Delete
  4. Hi STE,

    I enjoy your writing very much. However i couldn't find "Chan channel", would you mind to post a link. I can't seem to find the STI Index data, would you mind post a link which i may obtain one.

    Thanx

    ReplyDelete
    Replies
    1. Hi Mouse T,

      Thanks for the comments and glad to know that you enjoy reading my blog. As for the " Chan channel " , you may not be able to find it from webs as he does not published this online, you may find how he use and plot it from his books , also he is an author writing for " ShareInvestment.com" you may find the link as below:

      http://aspire.sharesinv.com/49183/dr-chan-market-outlook-to-get-brighter/

      and some of his details here : where you can find his books as well.
      http://www.ycchan.net/Bio.aspx

      As for the STI Index data, I use to download it from Yahoo Finance, now I could not find the link any more and I have to write down the data onto my excel file manually.

      I think some online biz web should have such data ..such as FT or Bloomberg where you may need to subscript.

      Hope this clarify.

      Cheers !!

      Delete

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