Being rational in the crowd of madness

Today, the STI ended up at 3567.14 or about 240 points (or about 6-7%) short of the all-time high made by the STI in 2007. By now, it appeared more and more people are thinking that a crash is around the corner. Isn’t this the same old story that started as early as 2011 in the midst of the Euro crisis when it was widely expected that Greece would likely be the 1st country in the Eurozone to default? That was already about 5-6 years ago. Every year pockets of people would shout of an imminent crash. More recently, when the STI passed 3600, it appeared that many more are clamouring that a crash is around the corner. But then, what happened to the real stock market in all these years? Dow Jones Industrial Index (DJII) broke its all-time at least 40 times since the global financial crisis. The NASDAQ punched through the 7,000 mark. Hang Sheng pierced through its all-time high several times, Nikkei 225 perhaps at 20-year high. And our STI, though miserable, still managed to climb pass 3600, second only to the peak made in year 2007. Naturally, when the market is on an uptrend, it must peak sometime in the future, but it may not necessarily end up in a deadly crash immediately thereafter. It can a be long-drawn side-way movement or, perhaps, a gradual decline. The question is when would be the peak and how it is going to happen beyond that? It may happen in 6 months’ time or 2 years down the road and the side-way movement can last for another 2-3 years. After that it can continue to climb or maybe decline. There are just infinitesimal ways that it can happen. So, why anticipate a crash when it may or may not happen somewhere in the near future? In fact, by haunting ourselves that a crash is near, we may risk ourselves into holding too much cash making us look stupid when the market is in a bull run. It may be alright to hold cash for one, two or even three years, but beyond that would be a big drag on our overall portfolio performance. Investing is like doing a business. We do not get into a business when the time is good and then get out of it when it is bad. If there is really a crash, we just have to face it, and steer through it and learn from it. We always read on the news that billionaires whose wealth got decimated 30%-40% during a market crash. But that was only a point in the time-line. With their steady hands, their business actually improved to a next level when the crisis was over. Only businesses that did not sit on strong fundamentals and poorly managed would end up collapsing like a pack of cards during a crisis.

Suppose we have $100k and we engage a fund manager to help us invest. After a few months, when we found out that the fund manager had put 50% in stocks and another 50% in cash. When asked, the fund manager replied that he stayed 50% cash was because he anticipated a crash somewhere in the near future. What is likely our next course of action? We probably pull out the fund, isn’t it? Why would we want to engage the service of a fund manager when he is only 50% engaged?   Isn’t it the same question that we need to ask ourselves if we are managing our own funds when we are only 50% engaged. Think about it. Even if our stocks were to advance 30% for that year, the other 50% that stayed as cash would yield at most 1% return from bank interest.  That puts us a weighted average of 15.5%, which was below the STI ‘s advance of 18% last year, which was considered as a very good year.

So much has said about holding too much cash. As a matter of fact, I also do not advocate holding only 6 months average monthly expenses as an emergency fund either. Without some cash at our disposal, it would be difficult for us to make opportunistic purchases that may pop up from time to time. So, end of the day, it boils down to a few basic questions of personal finance. What is our risk tolerance level and our comfortable percentage in holding stocks?

Historically, with dividends thrown in, stocks are a good hedge against inflation.  Personally, I would estimate the historical inflation rate to compound around 2% annually, apart from some seismic shocks that happened once in a while. That should be matched by about 2% in dividend growth rate in blue chip stocks, even though it may not necessarily advance in lock-steps with the inflation rate. So, it means that if we purchase a stock and never ever sell it off, we should, in essence, not be worse off.  Of course, this is not the motivation for buying stocks. With a bit of stock price volatility but, generally, with an upward trend in the long run, it is highly probable that we can make some money along the way. In a nutshell, stocks should be considered as an avenue to provide a reasonable rate of return in the long run. Based on this very basic fact, we really do not need to be an A-grader in school to make money from stocks. What is more important are traits like discipline, able to acquire some skills on valuation techniques, perhaps pick up a few basic money management skills and get some understanding of the market mechanism. That’s all it needs to gain from stocks in the long run.

Brennen has been investing in the stock market for 28 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.