Why you must avoid investing in the stock market! | Securities Investors Association (Singapore)

Date: February 25, 2015

The title of this article may seem odd however the intent was to imply that unless you are a full time stock picker/fund manager you should avoid buying stocks directly and if you must, limit such allocation to not more than 5-10% of your total portfolio. The reasons for making this seemingly outrageous claim follows:

1.	Understand Alpha: In simple terms, alpha is the return that your equity investments will generate above what a benchmark market index would have given you. As you may know from experience, it is incredibly difficult to generate alpha and to do it consistently over long periods of time is damn near impossible. Of course there are notable exceptions to this like Warren Buffet, John Templeton etc. however they are outliers and for the average person who has limited time and resources on hand, it is often a futile pursuit.

2.	Recognise the instinct to gamble/speculate: So why is it that most of us like to chase alpha? It is partly because people don’t even realise how hard it actually is to do so, but the bigger reason is the emotional aspect: the fun in trading, the gambling high of buying/selling. The ability to brag when your random stock pick does well and the ability to come across as a star among your colleagues/friends when conversation tilts towards investing. Most of us don’t even bother calculating how our self-managed portfolios really did in the long run compared to an index. From a wealth management perspective, you must realise that your whole portfolio should never be based on individual stock selection unless you are able to consistently generate alpha.

Do you know that even among the professional fund houses with analysts, economists and portfolio managers, on average only about 40% of the managed funds beat the index over a 1-year period and the percentage declines rapidly as the time frames are extended?

So if you are an individual who would be investing in the market for the next 5, 10 or 20+ years and if you were to pick and choose your own stocks, odds are that you would fail to beat the index over the long term consistently. In fact in all likelihood, you may end up doing even worse than fund managers given your lack of resources and time dedicated to do thorough research.

A much easier option is to consider buying an ETF which replicates benchmark performance or a mutual fund (while history is no guarantee, ensure that the mutual fund has at least replicated its benchmark and not under performed significantly). While ETFs are often a good option to consider there may be some issues you need to keep in mind such as:

Non-Availability of an ETF focusing on the desired region/sector/strategy.
The ETF may not be actively traded.
ETF exists but is traded on an exchange that you do not have access to.
ETF may not be denominated in a currency that you want your investment in.
It is often easier to take a loan against your mutual fund investments in Singapore but this option is usually not available for ETFs.
For emerging markets, it has been observed that a higher proportion of mutual funds generate alpha as compare to funds focused on developed markets.

Instead of doing stock specific research, it is more worthwhile to spend your effort in identifying the right region/sector/asset allocation and use fundamental as well as technical analysis methods to identify the product as well as the time to invest in it.

So sit back, relax and enjoy your time and focus your investments towards diversified products!

Find your next investment opportunity using the most powerful mutual fund search system.

This article is contributed by WeInvest

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