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

Successful Investment in the stock market is not just about luck or skills, it is a 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 importance 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.  Likewise, if we could get a 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 on 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, the stock market is like a Big giant casino, where traders and punters bet against each other in the short term.  

Base on the above chart, the market looks like “ casino’s Big vs Small “ with 50/50% chance on a daily basis … but if we invest in a 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 >

image credit to sbnonline.com

image credit to JP Morgan via ritholtz.com

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 the bond they should hold in their portfolio, but for younger investors, holding more bond should consider as riskier? But, how much bond/cash to hold will also be determined by “market valuation “ at a certain point of time ..ie “ Timing “ which I shall explain hereafter.

Compounding Effect: Over the TIME

"Time " is the key factors in making the " compounding effect " miracle.  Now look at the 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 the age of 56 but look at the subsequent years on how the compounding effect kick in that makes his multi-billion empire.

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

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 a 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 the “ compounding effect “, the amount accumulated is much higher than those start later.

Please refer to the below chart :

<PS: Of course do note that such an assumption might be too simplistic as the return might be different from year to year. The end result might be different if both have achieved a 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 ? Are we 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 explains the concept of Random Walk Theory in great detail : 

There is another school of thought who believe 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 behaviour 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. 

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

One may argue that we do not have such a 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 the 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 ".

STE's story: How I stage my war chest in the current volatile market

Easy said than done, good valuation only appears when there is a crisis . But during a crisis , the “ fear factor “ will rule and our emotional ( another element in my 6 factors strategy ) will determine our success in such a 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 the risk and there will be opportunities during a crisis. " Risk " is not knowing what we are buying or investing in and subsequently loss of capital permanently.

image credit to Finance.sina.com.cn

“ 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 the City University of Hong Kong ).

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

Remember that the stock market is about " probability ", not " certainty " .. as I have quoted in my previous post. Also, please take note that the 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 the long run.

Please refer to below link for more detail :

STE says to see crises as opportunities and accumulate

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

Please stay tuned for part 2 and part 3…

Cheers!

Quote Of The Day:

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

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

< For Chinese from Baidu >

http://baike.baidu.com/subview/581178/5125640.htm

< For English from Wikipedia and The School of Mencius >

https://en.wikipedia.org/wiki/Mencius

http://www.philtar.ac.uk/encyclopedia/confuc/mencius.html

image credit to sohu.com