Relook your investment premise

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I completely disagree with the author that just because markets are more volatile, we need to trade in and out instead of holding on to good companies for long-term capital appreciation!

The Straits Times
Apr 15, 2012
SMALL CHANGE
Relook your investment premise

Investors tend to make certain assumptions but it is hard to predict the future

By Dennis Chan

The financial crisis has exacted a heavy toll on the body and spirit of millions of ordinary people in the West as credit-starved governments begin to reverse years of profligacy with severe austerity.

It was sobering to read the report of a 77-year-old Greek retiree who shot himself dead after he accused the government in a suicide note of cutting his pension to almost nothing.

It read: 'I find no other solution than a dignified end before I start searching through the trash for food.'

One has to be a hardened cynic not to feel his suffering and that of others who are similarly struggling to get out of their financial hole.

Asia has been lucky so far. But we are certainly not immune to financial crises. Asia had its own blowout a decade before the United States subprime lending surfaced in 2008.

The subprime crisis, which has morphed into a sovereign debt crisis in Europe, has raised questions about certain assumptions we make about investing. I can list five.

The first assumption is that we can depend on our own prudent financial planning to set ourselves up for a comfortable retirement. This may be true in nine cases out of 10.

But all it takes is a black swan event to turn this assumption on its head. In countries like Greece, Ireland and Spain, many prudent individuals and families have fallen into poverty through no fault of their own.

A second assumption that needs to be re-examined closely is that real estate investment is a sure bet.

Some say the housing bust that badly ravaged countries like the US, Ireland and Spain will not happen here because Singapore is small. So while the Singapore property market has had its downturn, land scarcity will ensure prices will continue to rise in the long run. So the argument goes.

Even if it's true, taking the long-term view may not necessarily be the right yardstick.

In fixed income investment, there are two terminal values to consider when calculating returns.

One is known as yield-to-maturity, which is based on holding the investment until the bond matures and is redeemed by the issuer.

The other is known as horizon yield, which is the duration or time horizon in which you hold the investment. You don't always want to hold an asset till its maturity.

The horizon yield approach can also be applied to property investment, although theoretically freehold property has no maturity date.

But since one does not live forever, the tenure of a property may not matter as much as the duration of ownership. It could take five years or 10. It could even take 20 years or more if a property is passed on to the next generation. But there will come a time when an investment is eventually realised for cash.

Hence, long term does not mean forever. A period of 10 years is considered reasonably long.

But if you had invested in a property at peak prices (as is the case today), it may take longer than 10 years to break even when you are up against the property cycle.

For example, it took 14 years for the Urban Redevelopment Authority Index - which measures home prices - to surpass the last market's peak in 1996.

A third assumption is that interest rates cannot stay low for long.

I have to confess that I laboured under this belief when I decided to finance my HDB flat purchase in 2007 with a loan from the Housing Board at an annual interest rate of 2.6 per cent instead of borrowing from the banks at a lower rate.

Historically, HDB loans have mostly been cheaper than bank loans.

The global financial sector is awash with liquidity. As a result, interest rates are expected to remain at an exceptionally low level until late 2014, according to the latest quarterly economic outlook from OCBC Bank.

If this prediction pans out, I would have incurred higher mortgage interest for at least seven straight years.

The market value of Apple Inc, the world's most valuable company, is inching towards the US$600 billion (S$754 billion) mark.

Shareholders who have stuck by the stock would have seen their investment appreciate by 3,000 per cent in the last 10 years.

Every investor must wish he has the stock in his portfolio.

Which leads me to the fourth assumption.

In the past, it pays to be a long-term stock investor. I used to love accumulating stocks - both blue chips and second liners - hoping to find an Apple among them.

But this strategy did not pay off as some of the stocks I own are at a fraction of their peak values. I would have done better had I taken my profits.

Since the Lehman crisis in 2008, markets have also become more volatile.

As a result, the investor may be better off trading in and out of stocks instead of keeping them for capital appreciation and/or dividends.

The last assumption concerns the rate of return for insurance-linked products.

After my second daughter was born in 2003, I was persuaded to sign up for a savings plan that promises a decent payout at the time the girls enter university.

One of the few things I remember about the benefits illustration by the relationship manager was the projected rate of return. It was 6 per cent, based on past trends, he had said.

I was rather sceptical but against my better judgment, I took up two regular premium policies.

Since then, I have received two letters from the bank, each time informing me that the projected payout had been lowered.

The last letter stated a number that was 21 per cent below what had been presented to me initially.

At the rate it is going, the savings plan may just be able to pay for one year of tuition at a local university.

The projected 6 per cent annual return was a pie in the sky, underlining the investment axiom that 'past performance is no guarantee of future performance'.

These were just five assumptions that have turned out wrong. No doubt there are more.

They serve as a wake-up call that one has to be nimble and not be stuck in a particular mindset in a fast-changing investment environment.

dennis@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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