Why conventional wisdom might not be wise.

Many times we received good or bad intentional advice from our family, friends or colleagues which are peppered with conventional wisdom. Advice such as what course to study, how to study, career advice etc will always be given irregardless if you asked for it or not. The strong willed person (some say stubborn) will not be easily swayed and be able to stand up for themselves but the more easily persuaded person will tend to go with the crowd. I would like to point out certain conventional wisdom that is not so wise in investing or personal finance.

High Risk High Return

This is probably one of the most often quoted sentence in investment. In order to earn a higher return, you need to take on more risk. Even CAPM is based on beta which is the amount of systemic risk which cannot be reduced through diversification. Nothing can be further away from the truth because the more risk you take, it is more likely you lose all your money. This is one of those things people try to brainwash you to part with your money by saying you need to take higher risk to make higher return. If you have been told/taught this from young, there is very high tendency you will end up losing your money due to wrong concept application. The correct way is to approach it is low risk high return. The risk definition here is loss of capital (your money). Irregardless of stocks or properties, if the price you paid is so low, the likelihood of a good return is higher and capital impairment is lower (i.e buying a dividend stock of 10c dividend yield at S$1 vs S$2 is 10% or 5% dividend and likelihood of loss is lower at S$1).

For example, have you ever wonder why your mortgage interest rate is around 2 to 3% while your credit card debt is 24% per annum. That’s due to the risk factor involved. A mortgage is a formed of secured debt where you need to pay 10 to 20% of your house value and the bank owns the title deed. This loan is further backed up by your earning power hence in the event of default, there is a cushion of 10 to 20% to absorb the first loss. However, credit card debt is unsecured and only backed by your promise to return. Not back by hard asset. Hence the risk of default is so high that the bank has to charge a higher interest rate. This punitive interest rate is to ensure there is incentive for you to pay and the high interest rate cover the default of other borrowers. That’s why despite the more you borrowed, the lesser the interest rate! I know this sentence sounds stupid by itself.

This company sure won’t go burst

This is another favourite I hear when I discuss stocks or investments with my wife, friends or other investors. They will tell me companies such as Singtel, DBS, OCBC, NOL, Ascendas Reit etc sure won’t go bust due to their blue chip status. The singapore government (through Temasek Holding) have a stake in it so it is safe. This couldn’t be further away from the truth. Even if the company does not fold, it is still a drag on your return. Worse still you might lose money. For example, NOL which was a blue chip was sold to CMA. Long time investors might not be too happy as the price might be below the price they bought the stock. SMRT was another one. Hence even if the company don’t fail, it is still a poor investment.

One fellow even told me to buy Bank of China because even if the loan fail the China government will bail it out. I told him no thanks. If you buy with the idea that the government will bail it out, I will wait for that time to happen before I buy. LOL.

Dollar Cost Averaging the STI ETF

This is another example of conventional wisdom which might not be so wise. Many people adopt this because Warren Buffett suggested that if the wife is to invest, she ought to invest in a low cost index fund (I think is the S&P 500 ETF). So they also DCA the STI ETF since that’s the Singapore Equivalent.

The above is based on the the STI indicative weight in June. If you notice the weightage, the top 10 components are actually 68% of the STI. This means 20 counters made up the remaining 32%. Our index is heavily tilted towards banking and properties. The index components are revised frequently and companies which are not performing well will be taken out of the index and replaced with another higher market capped company. This selection basis almost guaranteed you will always buy companies expensive and not cheaply. Companies such as SMM, NOL and Noble have all been removed because of business facing issues and market capitalization dropping. A value investor will want to buy a good company in crisis and not when it goes up in price. Hence the STI ETF is inherently bias towards companies who are trading at high prices. Talk about buying stuff cheap and protecting your capital.

Secondly, the S&P 500 consists of 500 companies which are of different industries with a global footprint. I am not sure if the STI components are considered global. Regional yes. Hence when Buffett suggested that, he was not referring to STI ETF. He is confident in the growth of the US economy and not telling everyone to go buy their home index. One must take into consideration the context he was referring to before we misinterpret and apply it. It will end up being a good advice for the wrong result. The STI might not achieve the wide diversification and growth of the S&P 500 ETF so think twice before DCA the STI ETF blindly.

Looking at this chart, you notice that bear period are generally not long whereas the bull period is longer. If you use a monthly DCA method, it is very likely your average cost of the STI ETF will be higher and not lower. Capital allocation has to be active and conscious and not passive without consideration.  The Singapore Economy is a matured economy with low growth expected for the short term. I did not say it will be the same for the long term as technology factors might improve our GDP in the future since factors of production such as human labour and land are limited. My friend Derek from thefinance.sg also blog something about the STI ETF too.

Transferring OA to SA while you are young.

This is also a case of looking at profit and loss statement and neglecting the cashflow statement. The company who is reporting huge profit but has no cash will be in a serious condition. This is akin to someone who has a huge amount in his SA and not much cash in his OA to meet his mortgage or daily needs. One must always take care of the short term before thinking long term because Keynes once said this:

Conclusion

My point for writing this article is to bring up some thoughts to conventional advice we read or receive. If we want to be successful like Buffett, we will ask Buffett. Advice should be taken from the person who has walk the path you chooses (mentor) and not because others tell you so. We need to be able to independently assess advice and adopt or reject accordingly to our needs and the context it is applied to. Just because someone did it does not mean you should. Thank you for reading and hope this article trigger something for you to think about on a lazy Sunday.