Invest or gamble?

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Hong Kong is a great place to invest in stocks, as there is no capital gains tax, and no tax on dividends. So why don't more people do it?

Or more accurately, why don't they continue to do it? One reason is a confusion between gambling / speculating, and investing. If you've passed a jockey club outlet on race day, or been kept awake by a neighbour's all-night mahjong game, you'll know that gambling is popular here. That urge to make a quick buck means speculation pops up in other places too, including the property market, stocks, and even the McDonalds Snoopy collection!

Unfortunately, most of us are just not very good at being speculators. We hear friends and colleagues who seem to be making easy money on the stock market, and get agitated about what we are missing. We can't bear to be left out any longer and buy when the price is already too high, then despair when the price falls and end up selling at a loss. That leaves us feeling burned, with a view that the stock market is just too risky to try again.

But there is a way to force yourself to avoid this 'buy high, sell low' approach. The downside is that you'll never have anything very exciting to talk about when the speculators start their boasting. On the other hand:
- you won't have to spend any time worrying about this at all, it just runs on auto-pilot
- you'll end up with a lot more money than if you had left it in your savings account

This boring approach to investing is just to buy a set amount at regular intervals, and promise you won't sell it for 15 years or more. Take the Hang Seng Index (HSI) as an example. You use HK$1,000 a month to buy the HSI (eg buying the Tracker Fund), and promise you won't sell early. Warning: the 'not selling' will be harder than it seems. Looking back over the last 20 years (Yahoo kindly publishes the details), at certain times you could have followed this approach and after five years you would have 'lost' almost a third of your money. Of course you haven't really lost any money until you sell. But would you still hold it and wait, or would you get despondent and sell?

It's worth waiting. If you hold for 15 years or more, on average you'd earn around 7% annual interest. Again, nothing much to boast about, but compare it to getting say 3% from a time deposit at the bank:

years total invested final value at
3% interest
final value at
7% interest
10 $120,000 $139,630 $171,600
15 $180,000 $226,535 $312,102
20 $240,000 $327,281 $509,164
25 $300,000 $444,074 $785,553

I'm no financial advisor, but if you're ever tempted to buy a stock "because everyone else is", or "a friend says I can't lose" think if you really understand why you are buying it and when you'll sell it. Or would you be better with a simple monthly auto-pilot savings approach?

MrB

PS to our lady readers, you already know that the speculative approach isn't the best way to go. The April 15th issue of the Economist has an article 'A guide to Womenomics' which notes: "researchers have also concluded that women make better investors than [men]. A survey by Digital Look, a British financial website, found that women consistently earn higher returns than men. A survey of American investors by Merrill Lynch examined why women were better at investing. Women were less likely to 'churn' their investments; and men tended to commit too much money to single, risky ideas. Overconfidence and overtrading are a recipe for poor investment gains."

Comments

Value Averaging

The investment approach described above is called 'dollar cost averaging' (DCA). It's very easy to follow, and over the long term it generally gives better returns than leaving your money in a bank account or time deposit.

If you are comfortable with some simple calculations, you might want to take a look at a slightly modified version of DCA known as 'value averaging' (VA). It takes a little more work than DCA: DCA can be set up as an automatic instruction to your bank to purchase the same amount every month, but with VA you have to calculate how much to buy each time.

It's a simple calculation, and should only take a couple of minutes. Add the time it takes to make the purchase and you're looking at half an hour max. Purchases are made less frequently - it's recommended to buy just three or four times a year, and there's some review work recommended every couple of years. So allow about half a day's work, spread out over the year.

Your reward for the extra work is a better annual return. VA typically adds 1-2 percent extra return per year over DCA. eg in the example above, DCA returned 7% per year, giving a total of $785K after 25 years. If the VA approach returned 8% per year, that final total would increase to over $900K.

I haven't found any good explanations of VA on the web. There is a basic summary in Wikipedia, and a rather technical paper confirming the benefits over DCA. So the best source for further information is the original book on the subject, Value Averaging, by Michael E Edleson.

MrB