How to buy low and sell high

How to buy low and sell high
Most of us go through these stages in our lives.

Life stages

In our 20s, we think we’re freaking invincible and we can do no wrong. We know better than everyone else; everybody that has every loss money in stocks do not have the same unique insight we do. So we start picking stocks. We pick 5 to 10 “hot” stocks based on our analysis or tips from friends. Losses are blamed on “luck”. Wins are because we’re just that awesome and can do no wrong.

In our 30s, we realize our investments haven’t yet made us a millionaire. The expenses are increasing with the cost of kids and we’re concerned for their futures. After losing some money on our investments, we start thinking of “safer” investments. That’s the time we look at investment linked trusts and actively managed unit trusts. After all, professional investors and advisors should know better than us right?

In our 40s, we realize we are completely unprepared for retirement. That’s when the desperation sets in and we look to preserve our wealth. We want to increase our savings but realize our expenses are too much because the government isn’t providing jobs for the people. Then, we start screaming at the kids not to spend so much money; preach to them about frugality and how hard it is to earn money. Completely ignoring the fact we did the exact opposite of saving money when we were young.

Many people more or less goes through these stages. People are more similar than they like to admit but we want to believe we’re different. We want to believe that our investments will be “better” than the next guy. That our strategies will be better than the tried and true.

There’s a huge chasm between what most people believe makes investment success and reality. People believe that stock picking and timing makes up investment success. Stories like that little old lady who invested in Google when it first IPOed are sexy. The REAL things that constitute investment success like investing regularly, allocating assets and rebalancing are really boring.

So let me try to spice it up by showing you how to automatically buy low and sell high. I’ve spoken about Asset Allocation already. Basically, it’s a pie chart on how you want to invest your money. This pie chart should change depending on which stage of your life you’re in.

How do we buy low and sell high?

Stocks and bonds are roughly inversely correlated.

In simple terms, it means when :

  1. stock prices are high, bonds prices are low
  2. stock prices are high, bonds prices are low

There’s a whole mess of macroeconomics and portfolio risk theories that I won’t get into. (It will put you to sleep, I guarantee you).

Think about it, if both stocks and bonds grow at the same rate, then the portfolio should stay at 80% stocks and 20% bonds. Allocations will only shift if one area is outgrowing the other.

Essentially, when you re-balance, you’re selling stocks high and buying bonds low.

Let’s give some illustrations:
Say you’re in the life stage where you should be looking at a portfolio of 80% stocks and 20% bonds. At the beginning of 2014, you invested 800,000 in stocks and 200,000 in bonds. The economy went down the crapper in 2014 and stocks declined by 50%.

You’re now left with 400,000 in stocks. For illustrative purposes, I’ll assume that your bonds are at the same value. High grade, triple AAA rated government bonds like those issued by the Singapore Government should give you a steady return but I’ll assume the bonds stayed the same so it’s a little easier to understand.

Start of 2014
Stocks 800,000
Bonds 200,000

End of 2014 (Stocks down by 50%)
Stocks 400,000 (67%)
Bonds 200,000 (33%)

Overall, your portfolio has declined by 40%. And your allocation is roughly 67% stock and 33% bonds at the end of 2014. Now if you’re disciplined, you should sell 80,000 bonds and moved it into stocks. This moves the allocation back to 80% stocks and 20% bonds.

Start of 2015
Stocks 480,000 (80%)
Bonds 120,000 (20%)

Let’s say that 2015 turns out to be a fantastic year and stocks doubled. But bonds once remained the same.

End of 2015 (Stocks up by 200%)
Stocks 960,000
Bonds 120,000

So in total you would have $1,080,000 in your portfolio. Man I love playing with big numbers! If you did not rebalance, you would only have $1,000,000 dollars.

Start of 2014
Stocks 800,000
Bonds 200,000

End of 2014 (Stocks down by 50%)
Stocks 400,000
Bonds 200,000

Start of 2009 (Forgot to rebalance)
Stocks 400,000
Bond, 200,000

End of 2009 (Stocks up by 200%)
Stocks 800,000
Bonds 200,000

A smart investor like you would have ended up with $80,000 more because you were disciplined and re-balanced your portfolio.

Why don’t more people do this?

Mathematically, it’s really easy to understand, isn’t it? Just do a sum of your total portfolio and move money around until it get back to the correct allocation. Yet, Most investors don’t even have a plan for their asset allocation. They simply invest randomly here or there.

Many “investors” simply buy whatever stock that is recommended to them by their friends or read about online.

Then there’s the flip side of the coin, where a lot of well-read investors manually adjust their portfolio and diversify their investments by buying individual stocks. They want more “control”. The problem they’re leaving out is time. This category of people invests like how most people try to lose weight. They read a lot in a burst of enthusiasm, get everything set up and then slowly forget about it as time goes on. Most people can’t even go to the gym for 3 months.

What makes you think you can manage your own portfolio for 30 years?

Investment success requires a large amount of time. That’s why we want it to be as painless as possible. A system of regular investments, asset allocation and re-balancing works so well because it’s easy to follow. It’s a system that you can check once a year. Set a date once a year and get it done.

PS: If you want to learn more about investment strategies that work

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