Investing Is A Bit Of A Gamble

Foreword from ShareInvestor

This article “Investing Is A Bit Of A Gamble” by Melissa Tan was first published in The Straits Times on 24 Aug 2014 and is reproduced in this blog in its entirety.

Whether you are an average investor or a pro, there is no guarantee of success

My secondary school maths teacher played a game with us in class one afternoon that went by the rather appropriate name of Greed.

The details are fuzzy after more than a decade and I have long since lost the worksheet, but the premise was quite straightforward.

My teacher, Mrs Bala, would roll a die. If the number that came up was not a five, those in the game got to add the number to their theoretical pot of gold, with the goal being to end up the richest at the end.

If the number five did come up, though, everyone still playing would have all their balances wiped out in a stroke.

We could walk away with our stash by dropping out of the game before the next round – somewhat like a watered-down version of Who Wants To Be A Millionaire minus the trivia, theatrics and prospects of being able to afford a car afterwards.

It was, on the surface, a lesson on basic probability but what I recall more vividly is that one of my classmates chose to opt out after the third round with only six points.

She ended up winning.

The rest of us, having blithely carried on, all finished penniless around round six, which goes to show that the odds are unlikely to ever be in your favour.

As you can see, the sudden evaporation of all my imaginary cash remains permanently seared into my consciousness.

Prudence would have dictated that we get out early while we are still ahead. Those who did not paid the price, though to be fair it is a lot easier to be cavalier when the stakes are all hypothetical.

The pain of losing a game cannot compare, though, to that of losing real money.

I am reminded of this every time I open my monthly statement from the Singapore Exchange’s Central Depository (CDP), which dutifully tells me how my portfolio has been faring even though sometimes I do not actually want to find out.

The main cause of my dread is that one of the first few stocks that I bought is severely underwater.

Things had not always been this way.

I had picked up a few lots of the Catalist-listed penny stock several weeks after its initial public offering (IPO).

This was my second investment, made several months after I started work at the Money Desk three years ago.

I picked it partly because it was cheap enough to fit my very limited budget at that time.

It helped that I was buoyed by the relative success of my first buy, which had made some gains. If this one did well too, I reasoned, reinvesting the profit could take me one baby step closer to becoming independently wealthy.

I had also interviewed the company’s founder prior to its listing and thought that its business model seemed fairly solid.

His spiel about the rich pickings in his industry was enough to convince me that the firm had solid prospects.

Strike one: Drinking the Kool-Aid.

The counter seemed to have caught the wind in its sails as well as the eye of professional stock analysts a month or so after I took the plunge.

As its share price climbed steadily, heading to levels twice as high as the price I had paid, research houses launched into coverage of the stock, releasing a flurry of reports with target prices above $1.

“Double? Sell, lah!” my more experienced colleague said when he found out.

“Eh, but analysts think it can go higher,” I said, fuelled by optimism.

Strike two: Blind belief in brokers and, well, perhaps a touch of plain greed.

The stock peaked soon after and started to drift downwards as people started selling shares.

Faced with mounting evidence that everyone had moved on to the next punt and I had missed the boat, I decided not to sell again.

The logic, or lack thereof, was that the counter could possibly rise again in the long run based on its fundamentals and regain some glimmer of its former glory.

So far, that long run is proving to be a bit longer than I like, since the stock languishes tragically below its initial public offering price.

That was strike three, which I chalk up to a mix of overconfidence and loss aversion.

Those are just some of many possible cognitive biases that lead to less-than-ideal investment choices, which all investors would do themselves a favour to watch out for.

One major and common one is the Dunning-Kruger effect, which is that incompetent people tend to overestimate their skill levels.

In fact, they are often so inadequate that they do not even realise how inept they are.

Luckily, I invested only money that I was financially prepared to completely lose, which has not happened yet either.

A few lots of a penny stock also do not add up to much, so in the grand scheme of things, my paper loss has been small by most investors’ standards.

Though I would not go as far as to tritely claim that my worst investment actually turned out to be my best, I do see it as a cheap price to pay for a valuable education that could have cost me much more.

The rest of my investments have fortunately done well and keep my portfolio in the black for now.

One of them is the Straits Times Index exchange-traded fund (ETF), which is my go-to suggestion in the rare event that anyone asks me what to buy. This was the very first stock that I bought, on the advice of my business school professor, and I am glad I own it.

After all, it is hard to beat the market.

In fact, New York-based investment firm Richard Bernstein Advisors looked at 20 years of investment data and found that the average investor would have been better off just holding cash.

Calling the typical investor’s performance “shockingly poor”, the firm wrote in a note earlier this month: “The average investor even underperformed cash.”

Investment professionals do not fare much better.

Only two out of 2,862 mutual funds in the United States achieved that feat over five years, according to recent research by the S&P Dow Jones Indices team.

But hope springs eternal. Past performance does not guarantee future returns, so I am hanging on to that penny stock.

Investing might not be any safer than playing with dice, but for now, I am staying in the game.