Dear FAM, we heard you. To help you become a better investor, we have compiled more learning points in this article beyond what we shared previously that we believe will be of help to you in 2023 and beyond. This is because in investing, while history doesn’t repeat, it often rhymes.
At The Joyful Investors, we believe in dishing out purposeful content that advocates timeless investing principles as opposed to merely covering the next “hot” topic. Investing soundly is simply about sticking to the tested and proven principles and not following the hype.
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Basically, being a good investor also requires two things.
Decrease the odds of having catastrophic losses and increase the odds of you having outsized gains. Just like in competitive sports such as soccer, being able to defend well by conceding little goals and being able to score well. But just like it is impossible for a soccer team to not concede goals eventually, investors will also run into occasional pullbacks and paper losses as well.
So let’s break it down into these two parts— avoiding losses and maximizing gains. In this article, we will cover the area of avoiding losses.
A Russian writer Leo Tolstoy once said,
“To be wise one must study both good and bad thoughts and acts, but one should study the bad first. You should first know what is not clever, what is not just, and what is not necessary to do.”
The truth is that in the financial markets, most investors are talking about their winners and about the story of their huge returns. But, so rarely, do they talk about their failures. These pointers below may relate to you and if they do not yet, remember them at all costs.
Buying into IPO stocks or hyped-up stocks almost always seems like the smartest thing to do. This is because the financial media and financial writers around you will present their most compelling case why buying into them is a no brainer. Such articles or videos will run for weeks and it is easy for retail investors to be seduced by the overwhelming investment thesis and FOMO. When most finfluencers or financial writers that you follow are saying that something is the next best thing, naturally you would want to jump on it as well. This is also probably because of the many pages of writeup and “research” that seems to have been done for you and it is just so hard to imagine that anything can go wrong.
We share frequently in our Telegram channel that we do not subscribe to shares during their IPO stage. We avoid buying into companies like Fastly, Grab or locally listed stocks like Digital Core REIT, United Hampshire US REIT, Prime US REIT and so on. While some of these may be seemingly sound companies in their own right and that they may do well in the future, the fact is that IPOs are rarely priced to benefit the retail investors at the onset. The risk to reward often is not in our favor and most of the time we are buying into the hype. The odds are not in your favor the majority of the time.
When a stock has garnered enough growth and interest to be an IPO worthy candidate, oftentimes it is at the peak of its current cycle where the perceived value will be much higher than its true value. The IPO is released when we are at the highest level of euphoria and optimism for the stock or when the market is overly bullish on the future.
This is made even more possible with marketing campaigns to stimulate public interest. But with such hype, it has proved to be unsustainable time and again as there are many more people buying on emotions rather than on conviction. Even supposedly fundamentally sound companies like Facebook and Alibaba fell 50-60% from their IPO price before climbing back up.
On the other hand, for hyped-up stocks they attract a following where a large number of “investors” are in it more for the money than anything else. One of such examples is Gamestop and AMC Entertainment Holdings which all of us would have heard by now. Reddit’s infamous WallStreetBets army of retail traders pushed prices of meme stocks to the moon before it came crashing hard. When the going gets good, prices can go to an irrationally high level. But when the music stops, that’s when pain starts to set in and send prices spiraling downwards.
The unfortunate thing about hyped-up stocks is that, even if their fundamentals may be sound or improving like Tesla, it does not help to stop them from crashing hard because a significant number of these investors have little conviction in what they are buying into and there is a mad scramble towards the exit when prices move south. You may believe strongly in it but not the person next to you who has bought it. Fundamental and technical analysis do not work as well when there are too many emotions involved. Such stocks have a higher tendency to run up to irrationally high price levels (which chances are you will not sell them and can come crashing down really hard when it happens).
Generally, when an idea becomes too obvious and has a huge following within a short span of time, it is usually not a great idea. Do not fall for the shiny object syndrome. When it comes to investing in anything, there can be many reasons why you think you should be in. But just find that ONE reason why you should not and stick to your guns. Yes you may miss the occasional ones that really made it, but you would have saved yourself from many catastrophic losses which you might not be able to recover from for a long period of time.
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Listening too much to the financial media or analysts can do more harm than good most of the time. Many of the things you read are often a result of the price movements of the stock. The price is usually the thing that makes the news.
Which is why there is little value in reading articles or watching videos that, for example, say “5 reasons why Alibaba is down today” after it crashes. We often joked that these financial writers will be the very ones who would write an article on the same day to explain 5 reasons why it is not difficult to see why Alibaba stock went up should it have gone the other way instead. Financial journalists are pretty similar to what sports commentators do in a sports game. They are simply regurgitating what has taken place and then providing the reasons for such. Take it as entertainment and with a pinch of salt.
Ultimately as an investor, when we invest in a company, we must have developed our own investment thesis as to why we believe the company will be here to stay and continue to grow its earnings. Do not copy trade. Do not buy into a stock because Charlie Munger bought it, or sell something because he did. Every investor has his own reasons for each trade he makes which you may not see from his bigger picture. Unless there is a fundamental change to the underlying business of these companies that warrant our attention, most of the time what we see on the surface is mere market noises. At times, black swan events such as pandemic or the war can send shivers down the spines of investors as well.
In the short term, stock prices are highly influenced by the emotions of the crowd and mass psychology and have nothing to do with the potential and earnings of the company that you are invested in. Even strong stocks like Amazon and Google can retrace close to 50% from their highs. Which is why Benjamin Graham says that in the short term, the market is a voting machine. In the long term, it is a weighing machine that will really show you its worth.
Do not sell in panic and before you buy any stock, always ask yourself if prices fall by half in the next few months without a change in fundamentals, would it still be a stock that you are willing to hold on to. To be able to stay invested joyfully over the long term, an investor must be able to handle market corrections and crashes with aplomb and grace. It is only a matter of time it will come. Conversely do not be greedy when there is market exuberance. Do not rush in to buy when everyone else is. Rarely do you enjoy any margin of safety when you buy at high prices.
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Some investors got onto the stock market because of that one stock that they heard from their friends or financial media that is going to be able to make them a lot of money. They invest not to grow their long term wealth but with the expectation that one or a few stocks can make them rich by going to the moon. For that one investor who managed to retire by buying that single stock, there are countless who lost a fortune which is not made known to the public. Investing is not just simply about finding that ‘one’ or two companies and doing so much research on them that you think it becomes impossible for you to fail at it. They plough in all their capital at one go and make a bold investment (or bet) in that one or few stocks.
Risk management is a large part of the game and being able to stay in the game for the long run matters a lot. You can only do so by ensuring you do not get wiped out before the market rebounds. Think of it as a form of bet hedging that we see how some flowering plants in the desert behave. Every year, only a portion of these flowering plants germinate to cope with the uncertain rainfall. This is in response to the unpredictable environment of the desert where dry spells can occur for a long period of time. The remaining seeds serve as a backup for the future in case the current germinating ones do not have sufficient rainfall. Such a strategy will seek to maximize for a long term success and not about maximizing the results for any point in time.
Similarly when managing our portfolio, we must not sacrifice the longevity of our portfolio at the expense of short term moonshot thinking in order to maximize the returns for a period in time. That is why despite investors who invest in the U.S. markets which over the long term trends upwards, they can still be performing poorly or to have been out of the game altogether because they seek quick success and do not want delayed gratification. A wise man once said, “There are old soldiers and there are bold soldiers. But there are no bold and old soldiers.”
Generally an investor who just started out can consider limiting each stock’s position size to be no more than 20-25% of the total portfolio holdings. If you are new, you can consider diversifying among 10-20 stocks with a cap of 10% on any holding. Apart from diversifying between different sectors or industries, an investor can also diversify among different geographical regions and also time-diversify their entries. By doing so, we would be having a variety of flowering plants and not just one species and ensuring that they germinate at different times so that a single dry spell would not wipe them all out. Eventually it is still possible for a few of your bets to screw up but chances are you will still be able to recover from it and contain those mistakes.
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We like to stress the point that as an investor, the quality of the company matters more than the price that it is selling at. Cheap stocks can get even cheaper if they do not have the fundamentals to back it up. In fact even strong companies can become cheaper after you buy it although nothing about the company’s fundamentals have changed. The important thing to look at is whether the stock prices can recover in the foreseeable future, rather than if you are buying at the near bottom.
Some investors may feel that making money in investing is about buying low and selling high. And by buying say at the 52 week lows or 5 year lows, they will be in for a ride eventually. Hence they buy more as the price goes down, without considering that the market may be right. By buying low it doesn’t necessarily mean you can sell higher. This explains why investors were “all in” into companies like Singtel, ComfortDelGro Corporation, First REIT and Singapore Post Limited whenever they made new lows.
Some may even double down on the subsequent new lows after their initial positions had hefty losses. Theoretically it reduces your cost price but eventually what matters is how much are you able to sell it for in the foreseeable future.
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Everything has the potential to make you money. The question is how much can you make and at what odds and at what costs?
An astute investor must be efficient in his capital allocation and to be playing the games that he knows he has a fighting chance and that it is a worthwhile pursuit. That would of course invariably be dependent on an investor’s skill set and domain knowledge. Benjamin Graham can get his hands on value investing while Warren Buffett also does shorting put options.
But for someone new to investing, his best chance of doing well might be to buy the index and dollar cost average over time. There is nothing wrong with this generic advice. For a more experienced investor who has the ability to do stock picking or knows how to time the market through technical analysis, it would make sense for him to do so as well.
In short, as long as you operate within the confines of your domain, that is fine. That will also mean to steer clear of businesses which either you are less familiar with or historically where the odds are not in your favor. Avoid businesses where their profit pictures seem hard to predict in the years to come even if they are thriving now. Businesses where the demand and supply curve are very unpredictable and where threat of new entrants is a matter of time which will lead to reduced margins or possible obsolescence.
One such example where it is difficult for investors to make money would be in the commodities sector. In 2022, the commodities theme was presented in the financial media as a bright spot to add to our portfolio amidst inflation. It has been said that commodities could help to hedge against an inflationary environment like the one we are having currently and minimize a portfolio’s volatility. This cannot be further from the truth. In our opinion, investing in commodities such as gold or oil is an area which most investors may want to avoid. We find that even those who seemingly have done a fair share of research find themselves on the wrong footing more often than not.
In fact commodities are very complicated products where the supply and demand relationships are not straight forward. To become a true expert in even one of the commodity markets like agriculture, oil or gold takes a lifetime of study. And even these experts are known to get it wrong at times. Commodities by themselves are too unpredictable and owning a commodity is simply a bet on its production and consumption as compared to company stocks which have earnings and are productive assets.
Hence shun away from things where either you are less competent in or that the odds are not so much in our favor which would render you incompetent anyway.
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Margin or leverage can be a double edged sword. Most investors should not touch it unless they have a good track record of being profitable in the markets and are very well capitalized. As investors you must constantly remind yourself how difficult the markets can turn out to be and humility is just as important if not more important than being smart.
When you are highly leveraged, when the market tanks by 2%, your portfolio could well be down by 4%. With a bear market, the drawdowns can be unimaginable. A 25% market decline can become a 50% drawdown with leverage and trigger a margin call. When a margin call happens and an investor is unable to put in additional funds into the account, it can lead to forced liquidation of shares at unfavorable prices. These will become realized losses too. Never invest in money that you do not own or worse still to finance your investments by borrowing money from the banks or other people.
When an investor is taken out of the game and financially ruined, it can take many years to make a comeback or may never want to come back. As the saying goes, once bitten, twice shy. Many people have since stayed out of the markets after losing money in the previous crashes. This is one path that you must avoid at all costs.
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Investing in seemingly sound companies does not end with pressing the ‘buy’ button. From time to time it is important to revisit the fundamentals to see that the investment thesis still holds water. This in practice is not necessarily easy because it becomes harder for investors to think objectively about a stock once he owns it. Psychologically this is referred to as the endowment effect which is a cognitive bias where we value what we own more highly and what we do not own.
Investors who are prudent usually invest only in good companies. And generally, such good businesses continue to do well and do not give many problems. However, the world is dynamic and black swan events happen from time to time. The tail end risk of things is perhaps more prevalent than it is made out to be. For example, Covid-19 has disrupted the way things are and the structural changes may stay even after the pandemic ends one day. We felt that the Covid-19 pandemic has accelerated the adoption of remote working and tenants are downsizing their footprints. This may not bode well for certain office REITs with the increased risks of vacancies or in the downturn in the business of its tenants.
This led us to divest all our holdings in Manulife US REIT (BTOU) due to the declining occupancy rate for its office assets by May 2021. Another reason was also its lackluster performance on the technical charts. As of writing, BTOU has dropped by more than 70% from its peak. As we know by now, its distributions per unit of Manulife US REIT eventually fell year on year and gearing ratio has shot up unfavorably. We were lucky on this one and averted the crash. But had we been late to this, the right decision for us would be to cut losses and deploy the remaining capital elsewhere. Even if things turn out eventually fine for the US office REITs and prices went up, we would have no regrets about missing the rally as a sale was the optimal decision at the time it was made.
After entering at $1.21 at the end of March 2020 close to the bottom of the Covid crash, we eventually liquidated our positions by the end of January 2021 at $1.58. At the time of writing in late January 2023, the price was about $1.3ish and its distributions per unit fell by 12% in Q4 FY 2022 as compared to Q4 FY 2021. Recovery could be on the cards in the coming quarters but at this juncture, there are several other REITs that have better looking fundamentals and numbers which we would rather deploy our capital on.
Investors must remain open to divergent views and have an unflinching determination to seek out “disconfirming evidence” that goes against your initial investment thesis. Charlie Munger once opined that the openness to welcome the discovery of one’s errors when it comes to investing is an inestimable advantage.
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When it comes to income investing, some investors may naturally look for stocks that supposedly give the highest yield. And what happens is that they will fall into what we call a high yield dividend trap. Some investors might have also simply bought into REITs such as First REIT and Manulife US REIT by purely looking at the dividend yield as the only criteria.
Chances are, yields are unusually high for a reason. It could be high in order to commensurate for certain aspects of risk that the investor has to undertake. The higher yields could also be a result of a lower share price as investors are concerned about its future performance or its ability to sustain the dividend payout. Hence a high yield does not necessarily translate to a good investment. Interestingly, Manulife happens to have an article on “Don’t fall prey to the dividend trap.” which explains it too.
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By avoiding some of the points listed above, you can avoid some serious pain as an investor. Money that is saved and not lost will be able to work in your favor. A large part of investing well is not about doing it intelligently, but also the ability to avoid troubles and the courage to say “no” independently. This is also at the heart of what great investors like Charlie Munger primarily focuses on. It’s an interesting paradox to learn that some of the smartest people actually spend their energy on not doing stupid things which then give them the time and room to do the better ones. Too many investors have been so enticed in getting the prize that they conveniently look past all the stupidities that can prevent them from reaching for it.
If you have been guilty of some of these, do not be disheartened. Experience has taught us that one may gain the right skills with the wrong path sometimes which is part of the learning curve and all things will work for good eventually.
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Very useful knowledge. Thanks for compiling the learning points and neatly organized. 👍🏼