In Investing, Use Common Sense

Foreword from ShareInvestor

This article “In Investing, Use Common Sense” by Goh Eng Yeow was first published in The Straits Times on 30 Nov 2014 and is reproduced in this blog in its entirety.

Don’t expect to be 100% spot-on; don’t take unnecessary risks

Some of the best investment advice I ever got boils down to plain common sense.

A few gems were learnt in school, such as 18th-century scientist and inventor Benjamin Franklin’s sage advice that “a penny saved is a penny earned”. That observation remains relevant today, given the many temptations to get a person to spend more than he earns.

Now, if a person succeeds in saving some money and leaves it in the bank, the money will grow over time because of the interest paid. Albert Einstein called that process of earning compound interest the eighth wonder of the world.

Whether a person is rich or poor, he has an equal chance of compounding the interest because this process depends on time. That is why financial advisers urge people to start saving early. It maximises the compounding effect on their savings.

But merely squirrelling money away will not make you rich. For that, you must invest wisely.

That is where my favourite quote from investment guru Warren Buffett comes in: “Rule No.1: Never lose money. Rule No. 2: Never forget Rule No.1.”

Of course, it is impossible for anyone to be 100 per cent spot-on in picking his investments all the time, but the gist of Mr Buffett’s message is to advise an investor not to take unnecessary risks.

I find myself repeating this advice to younger investors who have the wrong impression that they can take big risks because they have youth on their side and time to make good any losses they may incur. But I know from experience how difficult it is to cut losses on a bad investment. The pain of a loss is always hard to bear.

Some people never recover from the blow.

Early in my working life, there was a major stock market crash in October 1987 – known in financial history as Black Monday – with Wall Street plunging by an eye-popping 23 per cent in a single day.

A good friend of mine had just started working in Hong Kong and he liked to place an occasional bet in the Hong Kong futures market. He would make a 5 per cent downpayment for a futures contract on the Hang Seng Index and hope to sell it for a profit before taking delivery of the contract.

Then New York crashed and the Hong Kong market was forced to close for four days as it waited for the storm to abate. When it finally re-opened, the Hang Seng Index plunged 33 per cent.

My friend’s downpayment was not sufficient to cover the huge loss sustained on his contract and he was asked to make good the difference – a cool HK$1 million (S$220,000 at that time). He could not pay up, he was made a bankrupt and his girlfriend left him soon after.

My friend’s experience flags the peril an investor may encounter during a market calamity, even though he might be taking what he believed to be an acceptable risk on his investment.

For advice on how to choose a stock – or for that matter, any asset – the best tip comes from Mr Buffett’s mentor, Mr Benjamin Graham: “If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”

When we go to the supermarket, we are likely to choose only the vegetables and fruit we would like to eat, that look good and are on sale at the right price.

Yet, when it comes to investments, there are people willing to plonk down big sums on a highly complex financial product after listening for an hour or so to a financial adviser.

Many of us probably also have a few counters in our stock portfolios which we bought on the spur of the moment because of a tip from a friend or remisier.

Some years ago, disgraced Wall Street financier Bernie Madoff described how he cheated highly sophisticated investors of more than US$18 billion (S$23.5 billion) through a simple Ponzi scheme which offered 11 to 12 per cent returns every year.

Even though there was no way any fund could do so well every year, nobody questioned him while he was delivering his payouts. He continued with his scam unchecked until it unravelled when he was faced with massive withdrawals during the global financial crisis seven years ago.

This too is familiar common sense advice that too many of us fail to heed: “If it sounds too good to be true, it probably is.”