Category Archives: Stock Market Investing

The enduring strength of Index Funds and fallacy of active investing

The demise of Neil Woodford has been coming for a long time and has ended in a bloody nose for the active investment fund management sector. As long been explained by investing legends such as Vanguard’s John Bogle and Warren Buffett, investing using index funds is the only sensible way to go for most people.

Tough time for active investment funds

Active investing is going through a roller coaster ride which started when investors holding the Woodford Equity Income Fund were locked out of their assets. Things did not feel right and it was not a surprise when a few months later it was announced that trading the fund would be shut down. It was a shock for those who did not take time to educate themselves sufficiently about investing, rather deciding to go with the “British Warren Buffett”.

When this active fund was set up in 2015, I was still a novice at investing and followed the hype, buying some shares as part of my portfolio. However, within months I switched the shares to passive tracker funds, taking in the advice gleaned from books such as A Random Walk on Wall Street by Burton Malkiel. This was fortunate, as people who remained in the active Woodford fund have made huge losses.

Performance of the actively managed Woodford fund is shown in the chart below. In this relatively short period the passive FTSE All Share Tracker outperformed both the active fund and all funds within its category.

Woodford Equity Income Fund Performance (Morningstar UK)

Woodford Equity Income Fund Performance (Morningstar UK)

Focus in Costs

Achieving Financial Independence would already be impeded by the very high fees charged by active fund managers (0.75% per year in this case) compared to passive tracker funds which can be as low 0.06% – 13 times lower! This can easily run into hundreds of thousands of pounds over an investing lifetime. Additionally, it is highly unlikely to identify a star fund manager who can beat the market consistently over the long term.

Vanguard is leading the way by cutting costs while active managers are raking in millions for underperformance.

Performance is further degraded by frictional costs due to the frequent trading by active managers; typically selling when prices are low and buying when they are up.  

Low information diet

It is best to not succumb to the heavy marketing from the City and have a low information diet. Talk about asking the barber for a haircut, and getting a bad one at that.

As active fund managers are experiencing vey high outflows in the wake of the Woodford scandal, it is not a coincidence that the S&P 500 index has almost crossed over its all time high. Diligent long term passive investors will be disciplined and not worried about all these shannanigans.

This episode proves what has been outlined time and again on this and other platforms which seek to educate about the benefits of investing in index funds.

Time in the market works, rather than Timing the market. Financial education and staying the course are key to long term success.

Interesting reading:

Why I am Optimistic about future investment returns

New York City Skyline at DuskFuture stock market investment returns are likely to be very substantial, even more so than past returns. This is an interesting topic as I have had a few conversations recently with people who believe that future returns will be lower than before or even negative. Their reasons do not seem logical to me; particularly because they are mainly based on short term thinking, ranging from a few months to a few years and lack of understanding of how the stock market works. 

A crash is coming!

The most common reason for pessimism about future returns is that a stock market crash is imminent because the market has sharply risen to very high levels recently. Having been a stock market investor for nearly 10 years I have heard this all the time but it has not deterred me from investing.

In fact, I have often taken advantage of this negative sentiment by buying more shares at depressed prices. Without fail prices have always come back to where they were, sometimes after what felt like forever, but the end result is an outsized gain.

The key is to believe in “reversion to mean” of stock prices and remaining invested by not touching yourlong term investments when volatility happens. It is best to take the long term view, typically 5 to 10 years or more.

Dow Jones Index Chart (1985-2019)

The chart above of the Dow Jones Industrial Index shows investment returns since 1985. Red bars are years of negative returns. It is clear that over the long term, buy and hold investors have benefited, despite a few short term shocks along the way.

Here are a few reasons why the future of investments is bright.

The rise of new industries

The S&P 500 index is packed with great companies which have thousands of workers striving everyday to bring value to Shareholders. Over time we have seen new industries come, becoming bigger and superseding what was there before. It is hard to imagine that Amazon, Facebook, Netflix and Alphabet did not exist 30 years ago.

New industries are always developing according to the needs of the time and the new companies providing the required services or transforming accordingly will surely reap the benefits. In-order to participate  in this, the intelligent investor will realise this fact and construct a portfolio which invests in the stock indices that will hold such companies.

Billionaire Space Race

A good example is the new Space Race. Private entities like SpaceX, Blue Origin and Virgin Galactic are jostling for stakes in this space and the potential is huge. Space tourism would be highly profitable and take various forms. Governments are already contracting such companies for International Space Station missions. Mining operations in far off places like Mars may become possible. Establishing a true industrial base in space is another objective. Reusable rockets drastically reduce mission costs, accessibility and time.

Innovation

The pace of technological innovation in this Digital age is staggering. Take investing for example. A few decades ago the process was very cumbersome as one needed to hold and mail a lot of stock certificates. Information was not readily available therefore very few people had access to this and brokers charged astronomical fees to everyday investors. Today one can research and buy global stocks instantly on a handheld device.

In this and other sectors, automation is increasing productivity and has potential to drive up returns. It is certain that innovation will continue to happen, offering new opportunites, products and services.

Population growth

I remember a time when the World population was hovering around 6 billion. Today this has jumped by nearly 2 billion and is trending higher.

World Population data estimate - 8 Sept. 2019

World Population data estimate – 8 Sept. 2019

The graphic above from here is very interesting. Net population growth appears to be very high. This fills me with optimism; many more potential users of goods and services than ever before. Astonishingly it took 200,000 years to reach 1 billion; and only 200 more to 7 billion. More importantly, these bigger markets will be more and more prosperous than ever before, fuelling the growth of current and future corporations. 

Too much Information

Every time I turn on the news it seems like the world is about to end. From trade wars, geopolitics, questionable economic forecasts to severe weather events it is not hard to see why some believe that a recession is around the corner. The facts outlined above lead me to believe the opposite. It is best to have a low information diet and focus on the facts.

Gaining financial independence requires discipline in saving and investing so staying the course is vital. Staying optimistic will provide motivation over the long term.

2019 Berkshire Hathaway Meeting – Top advice for Investors

It is that time of the year again when investors, big and small, descend in Omaha, Nebraska for the Berkshire Hathaway Annual Shareholders meeting. Warren Buffett and Charlie Munger have been fielding questions regarding diverse topics including business, the economy, Brexit, investing and life.

Here are the gems and insights I have managed to pick up from this year’s meeting.

Tech in focus – it is never to late to invest

In the past Warren Buffett has been reluctant to invest in Technology companies as he did not understand them fully. However, Berkshire has invested heavily in Apple during the past few years. Buffett says that the company has a “sticky” product.

In a surprise move, Berkshire has revealed that they have now invested in Amazon. Buffett admits that it was stupid for him to not buy Amazon stock sooner and it was one of his deputies who had actually initiated the purchase. He emphasised to not look too much into metrics when considering an investment and that Value Investing principles were still applied in the Amazon purchase regardless of the company’s very high Price to Earnings ratio.

This shows that it is never too late to start investing even if you feel like you may have missed the boat. To emphasise the importance of Tech, Apple’s Tim Cook and Microsoft’s Bill Gates were also in attendance at the meeting.

Global thinking

What initially strikes me as I watch the meeting is the global appeal of Buffett and Berkshire. The 40,000 plus attendees of all ages and from all walks of life come from many places, even as far as Australia, France, India, South Africa and China.

It makes sense to invest with a globally diversified portfolio as this will help to shield from any shocks in a particular region and should enable capturing gains from as many angles as possible. Responding to a question regarding the best approach to 5G, Munger said that Berkshire has bought in China before and is highly likely to keep investing there.

Unrealised gains can be misleading

$21.661 Billion! The first slide presented by Buffett was a summary of the 2019 first quarter after-tax earnings for Berkshire Hathaway. Accounting rule changes now require companies to include unrealised gains in quartely financial statements. As such gains are drastically impacted by share prices of investments owned, this can result in wild variations in results presented.

For personal investors working to Finance Independence the lesson is to not get too elated when the market surges or to feel down when there is a crash. It is best to stay the course while maintaining a high savings rate until goals are achieved.

Keep it simple

Referring to a question about alternative investments, private equity and using leverage when investing, Buffett warned that this is not something he would do. A lot of fund managers with “higher IQs” than him and Charlie got into trouble in 1998 when they employed such methods. It is a lot safer to invest in the simple index fund. Speaking of “alternative investments”, Charlie joked about being invited to a Bitcoin meetup.

Lay the ground rules and stick to them

This was an interesting one. A 27 year old aspiring fund manager had a question about knowing the right time to set up an investment fund. Buffett said that it is important to set expectations and rules when planning investments while not promising too much. This may result in having fewer clients but the expectations will be clear. A good way to keep focus on goals is to create an Investment Policy Statement (IPS). Figure out what works and do it.

Teamwork and Patience Works

Another top theme repeated over and over during the session was how Berkshire is operated so well by an excellent team of managers. Charlie and Warren are figureheads while there are several names including Ajit Jain, Greg Abel, Todd Combs and Ted Weschler who are also involved. I am certain that the future of the company is in good hands. Also worth mentioning is how patient Warren and Charlie are; moves are well planned and executed without any panic.

Asset Allocation and Opportunity Cost

Berkshire currently holds in excess of $100 Billion in cash or equivalents. There was a comment which outlined how this would have generated an additional $50 Billion if it had been invested in an S&P 500 Index Fund. Buffett acknowledged that this would have been the case given the recent stock market performance.

However, the cash pile is maintained for the benefit of Shareholders and as firepower to be deployed for “Elephant” sized acquisitions in times when it is raining gold such as 2008; times when no-one else is capable of making such investments. This can also apply in personal finance for example by holding a large proportion of a portfolio as cash or bonds when the intention is to deploy it within a short timeframe.

That’s it for this year. There will be more interesting tips and advice from the next meeting in May 2020.

Thanks to Yahoo Finance a webcast of the meeting (4 May 2019) can be watched here.

The benefits of investing in Index Funds

The demise of Debenhams is a stark illustration of the pitfalls of investing in a single company’s stock. Investing is good but it has to be done in a way which avoids high fees, minimises taking unnecessary risks or simply making non sensible choices. Index funds offer wide diversification and low fees which make them an excellent choice for most investors.

Pitfalls of investing in a single stock

Sometimes people can get emotionally attached to a particular company for one reason or the other. It is also common to hear some regret that they did not invest in a hot stock like Amazon, Facebook or Microsoft a gazillion years ago when its stock was still only worth a millionth of its present value. Everyone seems to have a story of an old colleague who made such an investment and is now rolling big.

However, there are thousands of such potential companies but you do not know or have the capacity to pick the right one unless if you possess a working crystal ball. To me, this kind of activity is akin to gambling on the horses. Debenhams, the British multinational retailer, was once a household name, particularly known for its huge department stores housing a wide array of goods and services. Any mom and pop investor would have chosen or advised others to invest in such a company. However the demise of this kind of business has been a long time coming.

Let us have a look at how the company’s share price has performed.

Debenhams share price

It is clear that any long term investors in this company would have been burned badly. Even worse if you owned a lot of stock and also worked for the company which is never an advisable thing to do.

The Indexer’s perspective

Now let us see how the stock has fared against the benchmark UK Index, the FTSE 100.

The differences are clear on this visual. Due to its composition of a wide array of companies in diverse sectors the index has steadily risen to outperform Debenhams and it certainly did not go anywhere near zero of the original value. When reinvestment of the FTSE dividend of nearly 5% is considered, returns would be way bigger than shown on the graph. Simply buying and holding while regularly topping up is the best strategy.

An index fund simply aims to track and closely match the actual index. It does not try to beat the market therefore costs are kept to a bare minimum compared to active funds which try to be fancy. Costs matter and along with maintaining a high savings rate are a major factor in determining portfolio gains over the long term.

To me this is compelling evidence that the sure way to building wealth is to regularly invest into a globally diversified portfolio of low cost index funds using methods outlined in this book. Progress will seem slow initially but the snowball will soon take shape and propel you to greater heights.

Interesting reading: