Quick Lesson: Specialisation VS Diversification

Specialisation VS Diversification. Thats the question most investors, traders, whether new or experience, ask.

Anonymous said...
"hi musicwhiz
if u look at BusinessedTimes diversification of over 10 stocks, one of the portfolio has a 300% gain over 5 yrs..."

I'll like to show everybody the insignificant of that return. "300% over 5 years". If you do your calculations, this is what you'll notice for $1 that you invest in that 10 stocks 5 years ago.

• End of Year 1 - $1.25
• End of Year 2 - $1.56
• End of Year 3 - $1.95
• End of Year 4 - $2.44
• End of Year 5 - $3.05

Impressive. Thats slightly over 300% over that 5 years. OR is it? I used 25%PA for that calculation.

"25% PA"

Thats the kind of returns you get in equity unit trusts with good historical returns (ie. Aberdeen Pacific Equity). When you invest in stocks, you'll want to be looking at better returns wouldn't you? Otherwise why would you be in the stock market? Why don't you just buy unit trusts?

"Whats the use of buying shares and achieving returns attained consistently in Unit Trust? Excitement in shares? Shares are not meant to be exciting. Its for investing."

On the other hand, I'll like to bring to your attention to the powers of compounded returns. It can really make your portfolio look really good. Imagine getting 50%PA on your portfolio in shares. It will look something like this.

• End of Year 1 - $1.50
• End of Year 2 - $2.25
• End of Year 3 - $3.375
• End of Year 4 - $5.06
• End of Year 5 - $7.59

When investors diversify, they are trying to spread their eggs into several baskets. A well diversified portfolio would usually mean 15-20 stocks, but it really depends on the amount of money you have. What diversified investors get is a pretty safe annual return that generally mimic the country's stock index. And thats a very mediocre return.

What unit trusts do is just that. They diversify their funds over large number of companies in their target market. The result is the same. Almost consistant annual return that mimic the country's stock index.

"So why don't you just buy Unit Trusts if you want to diversify?"

For specialisation, investors don't like to spread their eggs. Usually, this kind of investors hold a portfolio of 1-10 stocks. This kind of investors will usually get large returns that can range from 2-5 times the general market movement, but tend to be exposed to a lot of volatility and risks. However, this exposed risk can be managed by several precautions like "cut loss of -7 to 8%", which i preach.

Specialised investors generally know more about their companies they hold. They have more time to do research for their companies, and generally are better informed compared to diversified investors who are probably overwhelmed with information, especially during financial statement season.

Here's my take. If you were to diversify your own assets into many shares, its in my opinion that you should just buy into Unit Trusts. The returns for your diversified shares, compared to returns in Unit Trusts will not vary much.

"Buy into Unit Trusts, if you are looking for safe and well diversified investments."

Do note that when you buy unit trusts, its not necessary for you to buy 10 different unit trusts. Unit trusts are already very very well diversified. I recommend for you to own only 3-4 unit trust, with each targeted to different market.

If you are looking into larger returns in excess of 30% PA or even 50% PA, the route you should take is to specialise. Buy a few stocks, and keep track of those companies like a hawk. Every financial release, every contracts won, every movement in its management (Notice i didn't say keep track of the stock charts).

My recommendation for all is not to over diversify in shares, but to specialise in some. This way, you'll be looking at returns similar to the 2nd example above.

Quick Lesson: Cut loss, is that trading or investing, FA or TA?

I've created a controversy with some of my readers by practicing a "cut-loss" at the 7-8% point on my China Farm holding. So is that trading or investing? If the fundamentals of a company is that good, why be shocked at the 7-8% loss in shareprice?

Well, to recap. My China Farm shares were bought at $0.995, and sold at $0.915, for a 8% loss. If i was still holding on to my China Farm shares, I would be looking at a -25% paper loss, which would require a 33% rise to break even.

Emotions have to be taken out of investing. Yes, the ideal state will be to buy a fundamentally sound company and hold on to it through thick and thin. However, I wouldn't think its practical for relatively small investors like me and you (well unless you have a $5,000,000 portfolio, i'm talking about you).

When i was talking about "traders" and "investors", I'm basically talking about "traders" who practice Technical Analysis, who sits infront of a chart to find the pivot point and potential breakout point. "Investors" are fundamental analysts who look at the financial statements and research information to dictate their choise of investments.

Having a cut loss point of 7-8% does not make you a "trader". It can be a capital protection technique for "investors". Like me.

Quick Lesson: Fundamental vs Technical Analysis

There are 2 widely used techniques of analysis of share prices. Fundamental analysis which looks at the bottom line of a company, its management, its people and its products / services. Technical analysis generally looks at the stock chart and looks for known patterns that show good potential of breaking out. But which method is the better way to "invest"?

When I say "invest', its really different from "trading". The basis of technical analysis is really an assumption that price patterns are influenced by a company's financial performance, and impending good announcements. Most people who practice technical analysis are essentially, "Traders". They trade on the monthly, or weekly, or even daily basis. They spend lots of time going through charts to find potential break out points. Technical analysis assumes that historical price patterns repeat itself.

However, price patterns may not always repeat itself. When Traders buy shares using TA, they are exposing themselves to the risks of volatility of the daily market. TA teaches market timing. Many investors say you can't time the market. But traders claim they can. But the fact of the matter is, large returns of 100% or more are seldom achieved by trading. This is because Traders don't buy and hold. For most cases, they only hold for less than a month.

"Technical analysis practices market timing. Traders think they can time the market. Investors don't"

As a trader, how many times do you see yourself selling your shares at 20% gains, only to see it climb more than 100% over the next few months, and even 200% over 2 years.

Ask any successfuly investors like Warren Buffett, how do they buy shares? They invest. They look at a company's bottom line, the company's potential and fundamentals, and they buy the company and hold them for 5 or more years. They are the ones making compounded returns of 500% over 5 years. They practice Fundamental Analysis. They do not market time.

"Fundamental Analysts are the ones that make 100% or more gains. Not technical analysts."

Fundamental analysis base an investment on its future value. It really doesn't care about the comany's current P/E ratio. If a company grows at more than 25% PA, the high P/E ratio now, will be even out in future. In fact, most companies with High P/E are the ones that have good growth (>25%PA). Companies with no growth have low P/E. Investors and traders have nothing to look forward to, and no reason to increase the P/E. If you shy away from high P/E companies, you are missing out on good growth companies.

"With good EPS growth, a high P/E ratio is not a problem."

FA believes that over medium and long term, the daily volatility is taken out as share prices always climb in line with a company's earnings.

"FA removes the daily volatility and risks for a long term share appreciations in line with earnings."

You might say that in SGX, large returns (300%) thru fundamental analysis is nearly impossible, compared to the US market. However, you've got to remember that the SGX is very young. Singapore listed companies are young. Given another 50 years, the Singapore listed shares may mature its way to that of USA's.

Many times i hear people telling me that they bought Keppel Corp when its $2.00, and sold it at $4.00, and how they regretted not holding on to it (its $19.00 now). However, looking at their style of investing, they are traders. Many times they come to me telling me they made $1000 yesterday. But thats just 10% from one month. They are not the kind of people who would have held on to a stock. No matter what regrets they have. They are the ones that buy penny stocks in a hope that punters will have interest in them. They buy companies without knowing what the company does. They never learn from their previous experiences.

"You must tune your mentality to be a fundamental investor (holder), not a trader. This way, you will see larger returns."

Though both techniques provide good short term returns, it is Fundamental Analysis that assures an investor large price appreciation, removing all the short term volatility. The way to be a (very) successful is through fundamental analysis, not technical analysis. Fundamental analysis is the way to long term gains, while technical analysis exposes traders to lots of unknowns, and hence, lots of risks, with relatively less gains than FA..

Quick Lesson: Unit Trusts

As requested, many people have been asking me about my claims for high returns in unit trusts. I think this misconception is due to many not knowing and undetstanding the principles of unit trusts.

The basics
Unit trusts are basically funds "trusted" to fund managers to be invested accordingly. There are different type of funds. High returns (high risk), Balanced (medium risk), Income (low risk). Typically, high risks are invested largely into equities (shares) or properties depending on the type of fund you buy. Balanced typically mixed with equities and bonds, and Income mainly bonds.

How about the returns?
You'll be surprised. What are your returns for your shares last year? Think about it. Consider all the contra losses. Consider all your cut losses. Consider all your paper losses. Consider all the returns that you fail to reinvest cause you used the money to celebrate your 10% gains. Yes. My guess is that your return last year was less than 15%?

For aggressive unit trusts, Aberdeen Pacific Equity Fund. For the last 5 years, it has consistantly given me a return of 20% PA.

"20% pa only?!??!"

Mind you. At 20% PA, calculated monthly, your $10,000 would become $20,000 in 2-3 years.

"20% PA will mean double your investment in 2-3 years"

Another fund i own. Henderson European Property. Its given mea 40+% PA return last year. And from 2 -5 years ago, its given a 33-35% PA return.

"33% PA will double your returns in 1-2 years"

Remember, the stats above are assuming you reinvest all dividends and capital appreciation.

It just gets even better. My other holding. DWS China Equity. Its given me a 58% PA last year. And the fund is only 1 year old.

Does price of fund matter?
The price of a fund doesn't matter like shares. In fact, there is no such thing as P/E ratio of a fund. The only assurance you have of future performance of a fund is its previous performance.

"You don't look for funds that have bottomed out. Unit trusts don't work that way"

Why its previous performance? Isn't a unit trust that is too expensive dangerous to enter? No it doesn't matter. The reason why the fund is so expensive now is cause the fund managers's investment selections have been right for the last few years. Their investment model, their fundamentals, their asset allocations have been spot on.

"Funds that are expensive, with proven growth over the last years, are your best bet. They will out perform cheap unit trusts with bad performance."

Buy a fund on descend, you can only be assured that the fund managers don't know what they are doing.

Service charges are so expensive!
Consider this. If you were a share trader (notice trader not investor), you buy and sell shares 10 times a month, each time $5000 is traded. You've just paid $300, 6% has been paid. Thats alot of work for a month.

Banks charge 5% for unit trusts.

"Don't buy funds from banks, stupid."

Poems charge 1-2%. With very cheap fees for switching funds.

I'm currently buying funds with an wealth management company. 3% per buy, sell for free, switch funds for free. 1% PA for advise. I don't pay management fees by funds.

I don't mind paying for the services by the wealth management company as they monitor the performance of the funds, they have insider info on the fund manger's capabilities and i'm sure they are able to take care of my money well.

I don't have cash
Thats when you are wrong. have you thought of CPF? The funds above are all CPF OA approved. Imagine how much money you'll have for retirement now if you started 3 years ago?

"Would you rather risk your retirement by buying individual shares, or buy safer high return funds."

Even my CPS SA is growing at 10% PA (vs the 3% PA given by CPF), by investing in AIGIF Acorns, a CPF SA approved funds.

"Its never too late to start. Start now, be rich later"

If you were to buy funds the way they were supposed to be bought, you'll realise that the 3% charge is really insignificant to your investment. Its when you start trading funds (making 10%? cash it in!), thats when you'll see the banks growing rich.

If you need help in kick starting your investments in CPF in Unit Trusts, you can contact me. I can refer you to my financial adviser. From there you can find the value in their services and the 3% per buy (sell is free) is worth it. You don't need much money to start. Whats most important is that you've started.

Ps. i have no direct benefit from refering people to my financial adviser. I'm just sharing what i think is a good way to invest, and to grow your money..

Quick Lesson: What the Rich Does, and the Rest Don't (part 3: Compounded Interest)

It was in an article I read recently, that when asked what was the most powerful math formula known to him, Einstein said it was "Compounded Interest". Indeed.

The basic idea is simple. For every return in terms of capital gain and dividends, you reinvest them, to see exponential growth.

Lets say you have $10,000 to begin with. And assuming a return of 25% PA on your best investment (25% is achievable easily in Unit Trusts, so its conservative). You do not spend the returns on food or car. Calculated on a monthly basis, here is what the $10,000 would look like.

• 2 Years - $16,403
• 3 Years - $21,007
• 5 Years - $34,458
• 10 Years - $118,736
• 15 Years - $409,140

Time to buy the SLK you always wanted. But on the other hand, if you find yourself there with this kind of success, you'll not spend that money as just another 5 years. This is what you get if you didn't buy the SLK.

• 20 Years - $1,409,815

So, still want to buy your SLK?

Maybe spending your $1,000 profit in Sino-Env wasn't such a good idea? Though its tempting, I recommend buying shares on the notion that the returns are not "spendable".

So does that mean that after buying Share A and seeing a 100% return, I've got to sell it to see the compounded interest grow itself?

That was what I thought. But recently, I've got this revelation in my sleep.

Lets say you bought Sino-Env when it was $0.50. A few months later, you see it at $1.00. Thats a 100% return. A few months later, at $1.50, thats a 100% return from $1, but a 200% from your capital. From $1.5, to $3, thats a 100% return from $1.5, but a 600% return from your $0.50.

A $0.1 gain from $3 is about 3%. But from your purchase price of $0.5, its 20%. Need i say more?

Thats the beauty of compounded interest. Hold off that champagne to 20 years from now, where the champagne is 0.00001% of your gains, rather than 10% of your gains.

Quick Lesson: What the Rich Does, and the Rest Don't (part 2: Gambling?)

One important factor that the rich sets themselves from normal investors, is the way the rich look at investing.

Normal investors have to understand that investing in shares should never be exciting. Define exciting? When you find yourself sitting infront of the live price stream, and find a drop of 2% too much to handle, such that it makes you want to look at the price stream, hoping for more buyers than sellers.

If you are staring at the charts cause of contra trades, you are gambling.

In the past, with me holding shares of companies that have made +30% (and still holding), I no longer feel the thrill of the shares increasing in price. In the search for thrill, I made the mistake of finding excitment by doing contra on large movers. Maybe initially I'm able to make money, but gains were in the range of $100-$500 dollars, but losses were larger due to the large commission charges. In the end, I see my +30% gain in my portfolio become something more like 20% due to contra losses I made.

I can safely bet (and its a calculated gamble here) that 90% of successful investors never do contra. The gains from contra trading is too insignificant for the amount of time staring at the charts, and sleepless nights cause its T+2 already. If you were to hold on to good stocks, chances are 50% PA returns are very easily achievable. Together with compounding returns, you will see your $10,000 become $50,000 in no time. Try doing that in contra trading.

Quick Lesson: What the Rich Does, and the Rest Don't (part 1)

Many people around me always whine about how the rich seem to get richer, and the poor just stays poor. And when I'm talking about poor people, I don't just mean families or individuals that make less than $20,000 a year.

First of all, what makes an individual wealthy? By the car they drive? House? Monthly expenditure? You've got to understand, even if you make $5000 a month, but you squander away all that money within that month on luxury stuff, you might appear wealthy, but in fact you are not. Here is why.

Most wealthy have the ability to put aside a large proportion of their income to investment. Most of us don't. The wealthy have the ability to to that due to their large income. Many of us can't due to our small pay check. And even when we get a raise, we would just increase our monthly expenditure, and that includes our year end bonuses.

"The rich get richer cause they know how to spend their bonus and pay raise, not on material gains, but in investments."

Most of the wealthy people reinvest their investment returns. Most of us don't. Many of my peers make $1000 from their $10,000 shares, and immediately sell and splurge on a holiday or a material gains. They remain that "10,000-dollar-air". You should reinvest to enjoy compounded returns.

"Spending your profits in shares really leave you standing in Square 1"

The fact of the matter is, if you are interested in trading in shares, and you are here reading my blog, really means you have that spare cash (that you really don't need) to invest! So ask yourself, why do you need to spend the cash that you made on your investments?! Isn't it better for you to reinvest those gains, for larger absolute gains next time? Yes I do understand the need to enjoy yourself. My guide is not to use more than 10% of your gain on celebration.

"The fact of the matter is that if you are reading my blog, you probably have the spare cash that you don't ever need to use to invest. So stay vested."

So to answer the question, the ricch have the ability to not only make their capital grow, they know how to make their investment returns grow as well.

Over the next week, I'll be talking about "compounded interests" and several other things that the rich do, but the rest don't.

Quick Lesson: Should I Buy and Hold?

Most financial advisors will advising against contra trading or trading for the short term. They say that one should buy a fundamentally sound company and hold on to it, through thick and thin. However, I'll like to show you the other side of the coin.

The problem with buying and holding is that you might not maximise your returns. Lets say you buy a stock for $1.00. 2 months later, it rises to $1.50. However, a market wide correction occurs or even worse, a economy downturn causes the share to drop to $0.50.

Most of the time when this happens, most daily traders would have cashed in on their loss (if they were late in withdrawing), or made a profit less than what they could have made (if they saw the trend earlier). Institutional investors will stay in it, so long as the company fundamental has not change. If you believed those financial advisors, you would have stayed and suffered a paper loss of 50%. From there, do you realise you need a 100% gain to get back to your break even point?

"A 50% paper loss would require a 100% gain to reach breakeven point"

The difference with institutional investors and small time investors like you and me is the volume of assets we have in Equities. Most of us only have $100,000 or less in the market. The institutional investors have whats more like $100,000,000. They have the ability to move the market single handedly to their advantage. Could you do that? Thats their advantage.

The advantage investors like you and me is the ability to cash in on profits before an impending correction or downturn.

Use the advantage that you as a investor have. You are more agile than large institutional invstors. You can move from trend to trend quickly, mostly within an hour. They can't do that. When you "fight", you fight using the advantages you have. Its the same here in the stock market.

You have the upper hand in withdrawing from a downturning market. Use it.

Quick Lesson: Share Placement, the aftermath

When I first started studying the stock market, it was my understanding that the more the issued shares, the more diluted the supply and demand effect will be. When my company, Raffles Education announced a 30,000,000 share placement, i was worried. I thought it would dilute the market. Whats more, the EPS will be much lower. EPS is really what i work with. What i really wanted was a share buyback, to undilute the market.

But I was pleasantly surprised.

The stock increased over 2 days to $1.890. The same thing happened to Sino-Env, though the rise wasn't that significant, due to a previous rise prior to the announcement. So doesn't it defy the economics law of supply and demand?

Well, if you were to learn about placement, its not avaliable for people like you or me (unless you fish it out from your broker or other sources). Most won't issue this discounted placements to the public, for the obvious fact that its discounted. Daily traders would apply for the placements and for sure, immediately sell for quick profit.

The placements are usually given to investment companies or board directors who have a long term out look about the company. Hence it doesn't affect the "free floating" shares out there. The number of floating shares for daily trading remains virtually unchange as the new placements remain unreachable to the common market.

"The Free Floating shares avaliable to you and me remains unchanged after a placement"

What causes the price rise is probably the expected increase in earnings from a company that re-invests the income from the placement. Hence the subsequent price rise.