Warren Buffett asks you three questions.
First, if you buy hamburgers for the rest of your life, would you wish beef prices to keep rising or falling?
Second, if you change cars every couple of years, would you want car prices to increase or decrease?
Third, if you plan to save money and keep investing, would you prefer stock prices to rise or fall?
Most people would give the correct answer to the first two questions. But very few can give the right answer to the third. Most hope stock prices will rise after they buy, but they forget they will continue to invest in stocks.
Rising stock prices would increase the buying cost of your investment. Rising stock prices are actually bad news for most investors, unless you plan to sell all your stocks and retire soon.
By contrast, when stocks go down, you can get more for your money.
As long as the company keeps growing, its value will be eventually reflected on its stock price. Investors will get more return if they buy at a low price.
The episode is from The Elements of Investment, a book written by Burton Malkiel and Charles Ellis, professors from Princeton and Yale.
Malkiel is also the author of the influential investment book, A Random Walk Down Wall Street, and Ellis wrote the famous book, Winning the Loser’s Game.
At the age of over 70, the two co-wrote an easy-to-read guide on life-long investment principles that can help any investor succeed.
They believe investment is not that complicated, and investors can succeed if they do well in asset allocation and index investment.
Asset allocation means timely and disciplined investment. Investors have no rivals to beat, but they are usually beaten by themselves. Investors always want to buy low and sell high.
In fact, there were far more people buying stocks in light of the market surge that started in April this year. And we’ve seen many people sell stocks during the market crash in August.
The Hang Seng Index has hovered in the range of 19,000 and 25,000 points for most of the past eight years. Has the market offered opportunity to make mistakes or make profit?
Charles Ellis said: “Market timing is a wicked idea. Don’t try it — ever.” Many have tried to time the market, but most of the time they suffer a loss from their mistake.
Don’t expect you can buy a stock at the bottom, and get rid of market noises and news. Then you can share in the growth of a company and also take less time and effort and pay less money.
Many funds have outperformed the benchmark every year and continued to perform well.
However, that does not represent the future; nobody can assure anyone that champion funds can maintain their championship in the future.
Index funds will give you exposure to the whole market. You might miss one or two star stocks. But the constituents of the index should have satisfactory fundamentals, and enable investors to benefit from a market rally. Also, index investment is more cost-effective.
I want to add that the index investment is quite sensible in developed markets like the United States.
But the case is quite different in emerging markets like China, which has different star stocks from time to time. The Hang Seng Index may also fail to beat the market as half of its components are financial stocks.
Currently, everyone says Facebook, Amazon, Netflix and Google will become big winners in the future. If investors focus on internet and utilities sectors, they are set to beat the Hang Seng Index given the rapid development of 4G in the mainland market.
Asset allocation and index investment are simple but not easy. For example, to keep healthy, one has to have enough sleep, proper exercise and balanced diet. But very few have succeeded.
Few people can act with discipline, and they can’t resist fear and greed.
A disciplined approach to asset allocation should replace human emotions when making long-term investment. And index investment would bring good return with limited costs.
Of course, if you have strong confidence in China’s economic restructuring and your stock-picking capability, new economy stocks are a good bet for aggressive investors.
This article appeared in the Hong Kong Economic Journal on Oct. 7.
Translation by Julie Zhu
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