“Don’t look for the needle - buy the haystack”
Apr 26, 2020
There has been a sudden interest in the share market and it has me worried. I am noticing that there is a cohort of investors frantically rushing to invest in shares to “make the most” of this current crisis. It made me have a flick through this book that I picked up at a book sale a year or two back:
Except that this time, it’s not people ploughing money in and contributing TO a crash, it’s people getting super excited and ploughing money helter-skelter into the share market AFTER the crash.
During this time I have spoken to a number of long term investors who are making some strategic moves with their share portfolio by buying up shares in individual companies that their own analysis tells them is undervalued, but most of them made their moves weeks ago and all of them already have a well-diversified portfolio and feel that they can take on some calculated risk. But, many of these newer investors are just way too late to the party I’m afraid to tell you and are making decisions based on a lack of information because they are brand new at this and can’t possibly be expected to know what’s what. There is a lot of excitement about the share market out there at the moment but it’s exposing people to a lot of risks and putting their hard-earned dollars in jeopardy.
Possibly the most concerning for me is that I’ve been receiving a few emails from people who are looking to borrow against their own home to buy shares and I am ALARMED at this. Alarmed I tell you!!! And we are not just talking about $1,000 here, oh no, we are talking about $100,000 which is available to them on their revolving credit mortgage for example. When some people pay down or pay off mortgage debt, they leave that lending in place “just in case” and I’m noticing that some people are thinking that this ‘just in case’ moment has arrived.
And this thought terrifies me!!!
I’d said in a previous blog that a Sharesies webinar mentioned that they had 20,000 new sign-ups in March alone, bringing their total user base to 120,000 (no doubt it’s higher now). So, that’s a massive number of people jumping into investing for possibly the first time. And remember that they are just one of the platforms we can use to invest, so the other investment platforms are likely having the same surge of interest.
I know that a new investor with some spare cash is a dangerous combination because I vaguely remember the Dotcom Bubble in 2000 because Jonny and I were those new investors and parted with $5,000 on some tech stock, never to be seen again. There was a frenzy at that time of “just buy SOMETHING” which we well and truly bought into and it feels kinda the same now.
Now, I am 100% on board with being an investor, the sharemarket is a wonderful place to grow your wealth over your lifetime. But, I have learned a bit over the last ten years and I no longer see it as the ‘get rich quick scheme” like I used to think it was. And that’s my concern at the moment, I’m noticing people enter the share market for the very first time and they are suddenly willing to invest large sums of money (some of it borrowed apparently) to make a quick buck.
A friend summed it up well when she said that it “feels like the 1980’s” all over again, not because of what the share markets are doing, but because of the behaviour of people, rushing to buy ANY equity they can get their hands on and history tells us that these people will most likely fail and will lose their money. The NZX is experiencing a four fold increase in trading since the start of 2020. That’s huge and they are actually struggling to keep up with this volume of trades.
So, if you are reading this and are new to investing, I’m here to remind you that you need to calm the farm and slow down! And if you are reading this and you are not new to investing but your brain is screaming at you to “just do something”, you should also just calm down!
I’ve heard the following well-worn comments over the last month:
Timing the market
Picking the bottom
Buying shares cheap
I will double my money
Impossible to lose
I’m sorry to tell you that for the average person like ME about the only thing in that list that is relevant at the moment is that I can buy a unit in a fund more cheaply than before COVID-19. The rest is just crazy talk in my opinion. And once this all blows over, even if you do hear a mate boasting that they picked a stock and made out like a bandit, you might want to ask them what OTHER stocks they picked that crashed and burned and made them a loss…
And those who are invested in actively managed funds, well sorry to say but the majority are not guaranteed to fare any better at the moment as this blog post details: How are active managers faring through COVID-19?
What this blog post tells me is that those people whose full-time job it is to pick equities and build funds that their customers then invest in, and pay hefty fees to do so I might add, CAN’T select the winners, the shares that will give the greatest return. And if THEY can’t do it, with all of their experience and qualifications in finance, what hope do you and I have? None.
The graph that illustrates this best is this graph from SPIVA. There are no NZ stats available, the closest I can get is our neighbour, Australia, but the figures are showing how many actively managed funds underperform the index:
Graph showing the percentage of Australian equity general funds that underperformed the S&P/ASX 200.
So, when I hear from people who are looking to borrow large sums of money to invest in the share market by picking individual companies that THEY think will win, this is the information I think of and I just know that if a fund manager can’t do it, well, you have little to no chance and you are taking a huge risk by attempting to do so.
So please DON’T. Because you will lose your shirt and then turn around and think that it was the share market's fault, but it was not, it was yours.
What’s the answer?
So, what’s the answer and how am I investing during these turbulent times? Am I doing anything differently?
I’m running the risk of being boring because, yes, I CONTINUE to invest in just three broad-based funds:
NZ Top 50 (FNZ)
US 500 (USF)
New Zealand Property Fund (NPF)
My automatic monthly investments continue to happen on the 20th of each month and this is how the NZ Top 50 is looking for me since we first began to purchase back in November 2016:
Sharesight graph showing my SmartShares NZ Top 50 Fund over the last three and a half years as at 21st April 2020.
Our total return (after taxes and fees) with the highs and lows averaged out is still a healthy 10.61% pa. The ONLY change I have made is that I have been buying extra units in this fund (as cash allows) throughout this crisis, meaning that I did - by sheer LUCK - purchase at the lowest point and as the share market began to rise again, so the last month looks like this:
Sharesight graph showing how the last month looks for my SmartShares NZ Top 50 Fund.
As for the other two funds we have:
The US 500, which we started buying in June 2017, is showing a return of 13% pa (after fees and taxes).
The NZ Property Fund, which we started buying in June 2018 is currently down -9%. By investing in this I’ve chosen a more sector-specific fund (it invests in the commercial property sector) and it illustrates what can happen if you niche down, instead of just sticking with a fund that covers the entire market. Because the likes of shopping malls etc are in this fund and NO ONE is shopping and/or that the productivity of the large tenants of these properties is under strain, well that downturn flows through. Our holding in this is small for this reason.
The impact of COVID-19 has got a very long way to play out yet, so I am preparing to settle in for a long haul of market volatility as all of the companies that make up our economy and the economies around the world work their way through this. For me, I will stick to our BORING yet EFFECTIVE plan of steady investment over a long period of time into just three funds and I don’t want to throw all of our available money into the market when I might need some close at hand for my own use. Why? Well, the job market is so unstable at the moment so I need to keep some powder dry in case our income dries up AND I still want to be able to invest as per my schedule.
I’m looking at the whole picture of our life, not just focussing on the share market.
I have resisted all instincts to DO SOMETHING, to rush around and find those one or two companies that are at what I believe to be rock bottom prices so I can buy low and sell high. A quick search of “Sharesies” on Youtube will show you just how well buying too many funds and too many individual shares is working out for some keen young investors right now! It’s a shambles, but because the balances of their portfolios are so low, they appear unfazed but I can tell you this, they would be absolutely crapping themselves if they were ‘playing’ with hundreds of thousands of dollars at a time like this. I’m not going to link to any of them because that might look like I think what they are up to is a good idea and I can assure you I don’t think that!
Instead, I have calmly followed the advice of John C. Bogle when he said: “Don’t look for the needle - buy the haystack”. That’s what I’m doing, I’m just buying the entire market. Job. Done.
I had a nice catch up this week with a guy who has been investing for probably 45 years and he made the point that at my age (46) this turbulent share market is a really good experience to go through because I’ve had enough time as an investor to understand how it all works, enough experience to keep a cool head and enough time ahead of us to more than recover. He also said that during the next crash (or which there will inevitably be another) I might even have a chunk of cash available that I can throw at it and scoop up some bargains.
But you know what, I can see me probably doing exactly the same thing as I’ve done this time, just sticking to my plan of buying automatically over a long period of time, investing only in a couple of low-cost funds and not trying to predict the direction of a particular company. I’m a grown-up, with grown-up responsibilities like caring for my family, paying my bills, investing for retirement, earning an income and I’ve got better things to be doing than faffing around and taking unnecessary risks in the share market.
I have resisted the urge to DO SOMETHING, to buy individual companies or to sell any of the holdings that we have, thereby paying fees and locking in losses. To quote John C. Bogle again:
“Together, these two enemies of the equity investor - emotions and expenses - are sure to be hazardous to your wealth, to say nothing of consuming giant globs of time that you could easily use in more productive and enjoyable ways”.
So, by just sticking to my investment plan, I HAVE taken advantage of this drop in the share market, by being steady and consistent and I’ve certainly used my “time off” to worry less and enjoy life more and I encourage you, new investors, to do the same. And for those of you who have been at this a year or two but still have the wobbles, just take a deep breath, stick with your plan and don’t make any rash decisions. Don’t turn this share market crash into the wild west, turn it into an opportunity to learn how to be a steady investor, create a plan and stick to it and then like me, you can approach the next crisis with a cool head.
And I just wanted to share the mechanics of how index funds ACTUALLY work, because there is a lot of confusion out there with some thinking an index fund buys and sells all day long, that is not the case and the premise is surprisingly simple. I have taken an excerpt from a Kernel blog post as they explained it using fewer words than I ever could:
Here’s a simple example to help explain why:
Let’s imagine there is a new index and it only has two companies in it, Company A and Company B. Both of these companies have 100 shares on issue, and each share is currently worth $1. That means that each company is worth $100 ($1 per share X 100 shares). On the first day, because each company has the same value ($100), the weighting of each company within the index is 50%.
Let’s assume an index fund is launched that tracks the imaginary index and the fund has $10 invested. On day one, the fund manager needs to invest this money to match the index, therefore they buy 5 shares at $1 each in Company A and 5 shares at $1 each in Company B. The fund now has $5 invested in each company, and the weighting is 50% each, perfectly matching the index.
On day 2, Company B announces that they’ve made record sales and their shares increase in value from $1 to $2. All of a sudden Company B is worth $200, while Company A has had no news and is still worth $100.
What’s happened to the index?
As Company B is worth $200, it’s weighting in the index has grown from 50% to 67% ($200/$300), while Company A has fallen from 50% to 33%.
What does the index fund need to do?
Nothing!
Remember, the index fund has already invested their $10 and has 5 shares in each company. The value of the 5 shares in Company B has gone from $5 to $10 and the value of the 5 shares in Company A remains at $5. Therefore, the value of the index fund is now $15 and the weighting of Company B in the index fund automatically matches the weighting in the index ($10/$15 = 67%).
As the index fund doesn’t need to constantly trade to match the index, it keeps costs low.
Books
There are a couple of resources that are absolutely worth checking out. And I have deliberately linked to BOOKS because that way you will learn one of the ultimate skills of investing: PATIENCE. Once you order a book, you have to wait for it to arrive, you have to make time to sit and read it and then you might think about it for some time and then finally you might act. Take all the time you need, no need to rush in a time like this!
JL Collins - The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life
During the lockdown, I actually read The Little Book of Common Sense Investing - The Only Way to Guarantee Your Fair Share of Stock Market Returns, by John C. Bogle. It took me three weeks (because I was reading a trashy novel at the same time), but the timing could not have been more perfect for me because it reaffirms that I am on the right track. It’s a dry read, but it’s packed with wisdom and is now one of the few books that are good enough to earn a spot on my bookshelf. Here is an excerpt from his book which I thought was worth sharing:
“As you seek investment success, realize that we can never know what returns stocks and bonds will deliver in the years ahead, nor the future returns that might be achieved by alternatives to the index portfolio. But take heart. For all the inevitable uncertainty amid the eternally dense fog surrounding the world of investing, there remains much that we do know. Just consider these commonsense realities:
We know that we must start to invest at the earliest possible moment, and continue to put money away regularly from then on.
We know that investing entails risk. But we also know that not investing dooms us to financial failure.
We know the sources of returns in the stock and bond markets, and that’s the beginning of wisdom.
We know that the risk of selecting individual securities, as well as the risk of selecting both fund managers and investment styles, can be eliminated by the total diversification offered by the traditional index fund. Only market risk remains.
We know that costs matter, overpoweringly in the long run and we know that we must minimize them.
We know that taxes matter, and that they, too, must be minimized.
We know that neither beating the market nor successfully timing the market can be generalized without self-contradiction. What may work for the few cannot work for the many.
Finally, we know what we don’t know. We can never be certain how our world will look tomorrow, and we know far less about how it will look a decade hence. But with intelligent asset allocation and sensible investment choices, we can be prepared for the inevitable bumps along the road, and should glide right through them.
Our task remains: earning our fair share of whatever returns our business enterprises are generous enough to provide in the years to come. That, to me, is the definition of investment success.
The traditional index fund is the only investment that guarantees the achievement of that goal.”
