The pitfall of performance chasing
SOME people liken investing to gambling - you pick a game (market) you like, calculate the risks involved, put a bet (investment), and with a combination of luck and odds, you hope to walk away with a gain.
The truth is, investing is actually a lot more complex, and perhaps why it's not called gambling is that, while factors such as economic circumstances and local/global events (ie, what some call 'luck') play a part, these risks can be managed, or at least mitigated.
That said, investing really is all about odds. It's about figuring out how likely a stock, bond or other investment will yield returns, by how much, and by when.
And despite claims to the contrary by some individuals, we do not have the benefit of a crystal ball to gaze at to reveal the future. So instead, we have to look at current - and past indicators - to help us predict the future.
Last week, we talked about financial ratios, and how they could help us determine the health of a company. This week, we expound on one of the most important principles when investing: that the past performance of a company or investment is no guarantee of future results.
Many investors brush this statement off without realising how often they break this particular principle. In fact, there's an industry term that is used to describe such behaviour - performance chasing.
Some investors jump on the band wagon whenever brokers or industry watchers start touting a hot new asset class or sector.
They dump huge amounts into this new-found love affair, only to come away disappointed with the returns, which can sometimes even be in negative territory.
Worse still, some investors pull out current investments in order to help finance these new ones, and thus incur frictional expenses like commissions and fees, thus compounding the situation.
For instance, the latest high-end property boom has seen some people making amazing sums of money by buying and 'flipping' their units.
However, don't be fooled - there are also plenty of stories of those who assumed that there was quick money to be made, but ended up instead being unable to flip the million-dollar apartments which they had no intention of keeping in the first place.
In fact, history has often showed that in many cases, the best time to invest in a particular sector is after it's suffered some horrible industry trends.
So before you jump into that new investment you might want to ask yourself some questions:
Has this particular sector, industry, or stock experienced a sudden increase in price recently, and does this still make the investment attractive?
Have the prospects for better earnings already been priced in?
What makes you think the returns from this investment will be materially higher in the future than they are at the present time?
Another very important question you have to ask yourself is, how well do you know the investment, sector or business you intend to invest in? As a general rule of thumb, you should only go into businesses you understand.
For example, if you are thinking of buying into the stock of a property company, then you should understand the economics of the property sector. Based on your understanding of the sector, how far ahead can you forecast how profitable the company will be? How certain are you of that prediction?
So it really isn't a good idea to just jump into a sector or investment because you're afraid that you're going to miss out if you don't.
A more recent - and painful example, for some - was the Internet boom, which saw thousands of investors rushing head first to grab a piece of the pie.
As an intern at The Business Times then, I remember attending countless launches of new companies which had hit on the 'next big Internet technology that would revolutionise the world'.
And at every turn, gleefully heady angel and seed investors regaled me with tales of how the Internet would change the way we live our lives, and make plenty of companies rich, to boot. Well, it has - but today, less than a handful of the dozens of companies I interviewed are still around, and many investors have lost staggering sums of money.
The corollary to that is that there were also some stunning successes, and some very rich - and probably very retired - investors. So, there are risks, and there are rewards, but don't be silly and jump into an investment just because everyone else is.
As my grandma always said: 'If everybody decides to jump off a building, you also want to jump?'
Daniel Buenas
Mon, May 21, 2007
The Business Times
The truth is, investing is actually a lot more complex, and perhaps why it's not called gambling is that, while factors such as economic circumstances and local/global events (ie, what some call 'luck') play a part, these risks can be managed, or at least mitigated.
That said, investing really is all about odds. It's about figuring out how likely a stock, bond or other investment will yield returns, by how much, and by when.
And despite claims to the contrary by some individuals, we do not have the benefit of a crystal ball to gaze at to reveal the future. So instead, we have to look at current - and past indicators - to help us predict the future.
Last week, we talked about financial ratios, and how they could help us determine the health of a company. This week, we expound on one of the most important principles when investing: that the past performance of a company or investment is no guarantee of future results.
Many investors brush this statement off without realising how often they break this particular principle. In fact, there's an industry term that is used to describe such behaviour - performance chasing.
Some investors jump on the band wagon whenever brokers or industry watchers start touting a hot new asset class or sector.
They dump huge amounts into this new-found love affair, only to come away disappointed with the returns, which can sometimes even be in negative territory.
Worse still, some investors pull out current investments in order to help finance these new ones, and thus incur frictional expenses like commissions and fees, thus compounding the situation.
For instance, the latest high-end property boom has seen some people making amazing sums of money by buying and 'flipping' their units.
However, don't be fooled - there are also plenty of stories of those who assumed that there was quick money to be made, but ended up instead being unable to flip the million-dollar apartments which they had no intention of keeping in the first place.
In fact, history has often showed that in many cases, the best time to invest in a particular sector is after it's suffered some horrible industry trends.
So before you jump into that new investment you might want to ask yourself some questions:
Has this particular sector, industry, or stock experienced a sudden increase in price recently, and does this still make the investment attractive?
Have the prospects for better earnings already been priced in?
What makes you think the returns from this investment will be materially higher in the future than they are at the present time?
Another very important question you have to ask yourself is, how well do you know the investment, sector or business you intend to invest in? As a general rule of thumb, you should only go into businesses you understand.
For example, if you are thinking of buying into the stock of a property company, then you should understand the economics of the property sector. Based on your understanding of the sector, how far ahead can you forecast how profitable the company will be? How certain are you of that prediction?
So it really isn't a good idea to just jump into a sector or investment because you're afraid that you're going to miss out if you don't.
A more recent - and painful example, for some - was the Internet boom, which saw thousands of investors rushing head first to grab a piece of the pie.
As an intern at The Business Times then, I remember attending countless launches of new companies which had hit on the 'next big Internet technology that would revolutionise the world'.
And at every turn, gleefully heady angel and seed investors regaled me with tales of how the Internet would change the way we live our lives, and make plenty of companies rich, to boot. Well, it has - but today, less than a handful of the dozens of companies I interviewed are still around, and many investors have lost staggering sums of money.
The corollary to that is that there were also some stunning successes, and some very rich - and probably very retired - investors. So, there are risks, and there are rewards, but don't be silly and jump into an investment just because everyone else is.
As my grandma always said: 'If everybody decides to jump off a building, you also want to jump?'
Daniel Buenas
Mon, May 21, 2007
The Business Times
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