Why Do You Need to Invest?
The Story of Two Friends
Last week was a really thoughtful week for me. I had the good fortunate of catching up with two groups of friends and naturally I began talking about investing (bad habit!). Of which, two encounters really stood out.
I haven’t had the chance to ask for their permission to share the stories so I’m gonna use alias here (anyway the name is not important, the message is)
Source: STjobs.sg
Why Do People Fear Investing?
Both X and Y work in the financial sectors. X works in a large international bank while Y is an equity analyst of an investment firm. Naturally, one would imagine that given their daily interactions with the financial markets and products, they would be avid investors or at least be comfortable with investments.
However, nothing could be further from the truth. Both of them do not invest at all, and the common reason shared was risk. They felt that the level of risk in investing, be it the stock market or any investment, is too high for any individual investor. One of them even joked that her mother was a better investor (I must speak to Auntie one day).
While keeping a smile on my face, I was in a state of disbelief. These folks are among the smartest minds of my generation (do you know how hard it is to get into banking and investments?) and they have both struck a successful career in the financial world. If they don’t dare to invest in the stock market, who would?
There is a stock market under my bed!
Indeed, this is the current state of our society where the public is ultra risk adverse. They want to avoid making investment mistakes which could jeopardise their financial situation. In fact, a 2014 UBS study showed that the millennials (born between 1980 to 2000) reported a risk tolerance about as low as those in the WWII. Locally in Singapore, a Blackrock survey showed that the average individual cash holding is about 48% of their portfolio, while the equities holding is a mere 18%.
However, after I calmed myself down, I realised that this is not unexpected.
In the past decade, most investors, in fact the whole world, have been scared stiff by the stock market. We had the Asian Financial Crisis in 1997, the Dotcom Bubble in 2000, the Lehman Crisis in 2008, the China Black Monday in 2015 and the most recent Oil Price Crisis in 2016. If anything, it looks like the frequency of a stock market collapse is increasing. Therefore, many flee to the safe harbour of cash. The Blackrock survey also found that 38% of the Singaporeans are planning to hold their savings in cash upon retirement.
Perhaps Cash is King?
Yet, amidst these crisis, we should question if holding large proportion of cash in your portfolio is the best thing to do? Does holding cash really protect you from losses?
And the simple answer is no. Take a look at the picture below. The purchasing power of the U.S. dollar has been decreasing since its creation. In fact, if you were to hold on to a $100 dollar bill from 1900 till 2012, the $100 dollar bill will only be worth $3.80 in the current U.S. dollar (Although the physical paper money would be a collectable.). You would have lost almost 97% of its original value. Ouch!
Source: Credit Suisse
While this losing phenomenon is over a long period of time, we are also experiencing annual loss of value in our cash. It is called inflation. On average, a $100 bill loses about 3-4% each year. While this may seem like a small percentage, it adds up really fast over time.
You must have heard the common complaints such as, “Things used to be so much cheaper” or “I used to pay 50 cents for this, and it is a dollar now?” Actually, things weren’t cheaper back then, it is the price that has gone up.
Therefore, if you look at holding cash from this perspective, a large proportion of cash in your portfolio may not be the best thing to do. By holding too much cash, you are almost guaranteed to lose a lot of money over time. This is why financial advisors and investors are encouraging people to put their money to work – to invest!
Not to go into too much of investing methods here, I will just share the most basic and simplest way of investing I know. If you know of anything simpler, please share with me in the comments!
In its most hassle-free form, investing can be very simple. With the rise of Index Exchange Traded Fund (aka Index ETF), anyone in the world can easily invest in the global markets. Previously, China investors could hardly invest in the US markets and vice versa, let alone buying into the market as a whole. But with Index ETF, you can! (In my opinion, ETF is the eighth wonder of the world)
Index ETF For The Win!
One example is the Russell 3000. It basically measures the performance of 3,000 publicly held US companies based on total market capitalisation, which represents approximately 98% of the US equity market. In short, if you invest in Russell 3000, you bought a slice of the whole US market. (How powerful is that?) Take a look below.
Source: Yahoo Finance
You will notice that while the US market is volatile in the short terms, it is certainly moving upwards over the long term. For example, if you have invest in Russell 3000 during the Lehman Crisis in 2008, most people would have regarded that as the worst time to invest. However, if you have kept your investment, you would have emerge profitable in 2016. A $100 invested in Russell 3000 in 2008 would have returned 235% in 2016.
In fact, investing into Index ETF will guarantee you returns similar to market performance for your portfolio. Generally, it is about 8-10% depending on the countries and region. And that is not too shabby! Many fund managers struggle to achieve parity with the market returns.
Contrary to popular belief, holding too much cash is a certain loss. That’s real risk for you. I highlighted in another post about how much cash you need to save aside, and the rest you can safely invest. I hope this quick example illustrates to you that investing in the stock market is not as risk as you may believe, when you are investing for the long term.
Remember, investing is not gambling. It is building wealth.
See you soon!
Investing Always,
Pete
p.s. X and Y, I hope you don’t mind me using our conversation to craft this post =)
