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Monday, April 14, 2014

Bill and Ted's Excellent Investing

Today we have a guest post on investing from a new blogger: Islands of Investing. Hey, where are you going? Wait! Don't leave! I know your first instinct when being told of a guest post is to click away and read some other post from one of your old standbys. But this is a legitimately good post on investing, and the mistakes we can make with our money. If you don't stay and read it, you will probably be poor and unpopular forever, and will likely regret this one key decision when you look back on your life from your deathbed.* Don't let this day be another wasted one, filled with feelings of what might have been. Carpe...something.

*Disclaimer: reading this post will probably not have any material impact on your wealth, popularity, or anything else. The blog does not recommend any specific form of investing, such as picking single stocks. Like everything on this site, the following post is for entertainment purposes only and should not be considered investment or financial advice. Consult real professionals before making financial decisions.You have been warned.

If you’re on a mission to become financially independent, you’ll already know that investing is an important part of your plan – both in getting there, and in keeping you there.

The great news is you have the potential to be a fantastic investor.

Unfortunately, many people doubt their own abilities. One of the big reasons for this is they think the secret to success is to ‘pick the winning shares’ – the next Apple, Amazon or Google. Like trying to hit the jackpot, or find Willy Wonka’s golden ticket.

If you’re one of the many people who believe this, you may never have even tried to become a good investor. But picking the next big thing is not the answer to your investment dreams – even if you could pick it.

To understand why, I’d like to share a story about two investors*, Bill and Ted, who both bought some shares in a fantastic company called XYZ 10 years ago, at a similar price….

Bill’s investment in XYZ

Bill bought 10,000 shares of XYZ at $0.50 each (a total investment of $5,000).

Bill held his shares for 10 years, never selling or buying more (he doesn’t watch much news, doesn’t check share prices that often, and doesn’t trade often. Although he is pretty busy living a great life…)

XYZ turned out to be a great success. Today the shares are worth $10 each. Bill’s $5,000 investment is now worth $100,000. Wow. Great share picking Bill!
“If only I was lucky enough to pick those shares!” I hear you say. Well, Ted was also lucky enough to pick them, but his results were a little different…..

Ted’s investment in XYZ

Ted heard about XYZ from his favourite share investment newsletter. He watched it for 12 months, because he didn’t know whether it was really a good investment – he doesn’t have his own criteria to test it against.

Only four months later, it has risen 70%, and everyone in the media is talking about what a great share this is. Nearly all brokers recommend it as a buy. So Ted jumps on this bandwagon and buys for $0.85.

Things go well for the next 6 months. His shares are up 15%. But he’s been reading in the news that ‘the market’ is worried about China. Sounds serious. Over the next week, ‘the market’ is down every day, falling a total of 6% over the week. XYZ falls 8%. Ted is nervous. He sells. “7% gain – can’t complain about that!” (before taxes and transaction costs).

He keeps watching XYZ out of interest. Over the next 2 months it falls a little below the price he originally bought. “Phew, glad I sold when I did!”. He pats himself on the back.

Three years later, XYZ has had some great success, delivering increased profits and dividends. Ted had forgotten about this investment, but since it’s in the news again it’s back on his radar. “There’s no way I want to buy now though – it’s up 300% on when I sold it! I’d only buy if it got much closer to that price again!”. He’s anchored to his previous selling price.

The success of XYZ continues. There are some small share price drops occasionally over the next couple of years, but the share price continues its trend up. Turns out to be a pretty great investment after all, and still at what appears reasonable value. But Ted still refuses to invest. He can’t possibly buy these shares now and admit he made a mistake selling them many years ago.

A full eight years later, and ‘the market’ is doing fantastically. Everyone’s talking about how great shares are doing, including XYZ. Almost every broker has it in their ‘top 3 best buys’. They’re saying it could rise another 20% this year. Even Ted’s friends recently bought some shares!

Ted’s missing out on the gains. He feels the pressure mounting. He hates this feeling of missing out.

So he bites the bullet and buys (and why not, after all he has some funds available – he just recently sold some shares in another potentially great business, BCA, for a nice 10% gain (before taxes and transaction costs). “Yesss!”).

 Aaaaah. Pressure gone. Now just ride the wave to riches.

Nine months later, there’s a market wide ‘correction’ – news of a civil war breaking out in some Asian country has everyone nervous and selling. XYZ is now down 8% from what Ted paid. He decides to sell when it gets back up to his purchase price (he hates making a loss!). But each day it slides a little more, and each day his stress mounts. 10%. 12%. 13%. 15% down. Panic stations! Ted sells. He can’t take it.

Three months later, the potential war is long forgotten. XYZ is back above what Ted originally paid. The world seems great again. But not for Ted. To top it off, those shares in BCA he sold about a year ago are up a further 35%! Damn it!

Ted gives up. He’s just no good at picking shares….

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Your past experiences probably won’t be exactly like either of Bill or Ted’s. You might laugh at Ted’s terrible investing abilities, or you might recognise some similar experiences with your own past. Although like Ted, you might not even realise that you had previously invested in some ‘winning’ shares, unless you’ve revisited some old investments.

But the point is that you can achieve drastically different results when investing in the same share. The share itself is not the answer to your investment dreams. For XYZ, your returns could have been anywhere between a large loss (with frequent trading) and a 2000% gain.

Where you fall in this range will depend on your own plan, strategy, investment criteria, skills, experience, ability and attitude (and of course, a little luck).

This is also not to recommend buying and holding shares forever as the best approach (but I think it’s a reasonably good one). But it’s an approach that suits Bill, and has worked well for him in this example. We could pick another example of a terrible share investment that has been declining for the past 5 years. If Bill did the same thing, he would most certainly lose money, whilst it’s possible another investor bought shares when they were significantly undervalued, and sold then for a gain when they were ‘reasonably’ valued, despite the broader downward trend in the share price.

Consistency is waaaay more important than hitting one home run. Just like winning the lottery won’t necessarily make you rich (for long), and is very unlikely to change your ability to manage money well – we’ve heard all the stories of people hitting the jackpot one way or another, and being right back where they started after a few months or years.

So by all means, seek out great shares to invest in. But more importantly, continue to develop your own plan and investment criteria, and your investment skills. Because whilst picking winning shares can be fantastic, it is not the main game of investing – you don’t need to pick the shares of the decade to achieve great success. And as Ted will tell you, picking great shares does not guarantee great results.

* Purely fictional characters 

Photo of Bill and Ted, which is oddly the only one I could find on Flickr, is from Sylvar at Flickr Creative Commons. If you'd like to read more from Islands of Investing, you can find his blog here.

35 comments:

  1. This is why I love automatically investing in index funds and ignoring the financial news. It is pretty hands off and allows me to focus on my savings rate instead.

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    1. Hi Leigh - yes this is definitely a great benefit of automatic index investing. Although the 'low information diet' on the news is also a big help in being hands off with the index funds - you're less likely to succumb to market panics or doomsday headlines and sell out.

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  2. Great message. And any great message is better delivered through a Bill & Ted example!! :)

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    1. Thanks moneystepper! Very glad you liked the message! Bill and Ted have been a little quiet in recent years, so I know they were more than happy to share their investing experiences ;)

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  3. Thanks so much DB40 for the opportunity to share this on your "most excellent" blog! Not to mention your fantastic introduction and great work with the picture! Greatly appreciated!

    It's a real thrill to see this posted on your blog, and I hope your readers find some value or enjoyment in it!

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    1. It's my pleasure. I'm always happy to host a good guest blog post, and this one qualifies, for sure.

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  4. Great post!
    One thing that's also worth considering is that even if Bill and Ted followed the same buy & hold strategy, their returns may swing dramatically depending on when each of them decided to make their initial investment.

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  5. Thanks StudyOfWealth!

    Yeah, timing can definitely have a huge impact on returns, even if two people follow a similar approach. And particularly in this example with a lump-sum payment invested at single point in time.

    But whether we manage to time it well or not so well, we can have some unfortunate behaviours as investors that can cause our results to be worse than they would otherwise be.

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  6. I'm a buy and hold kinda gal. Timing is everything.

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    1. Hi Stefanie! Buy and hold definitely has a lot going for it. Timing has a big impact – the price you pay really does impact your returns. But timing is a tricky one to do well, which is why many people stick with regularly contributing to investments rather than trying to ‘pick the bottom’.

      I also think that time-in the market is everything too, to make use of the magical power of compound growth.

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    2. I agree with Stefanie. My approach has always been to initiate a position in a worthwhile stock when it gets cheap enough, based on the fundamentals I hold important. As shares get cheaper and the fundamentals hold I continue to buy. When the fundamentals drop but the stock rises, it's a great time for me to get out and move on.

      An important point with all of this is that there is always going to be another stock out there. So sense in getting attached to XYZ when there are tens of thousands to choose from.

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  7. In the immortal words of Bill and Ted, the message of this post is...most excellent dude!

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    1. Thanks Brian!! (*air guitar sound effects*!!)

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    2. Ha ha love this.

      Great article as well Jason, and good luck with the blog!

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  8. Gotta love the Bill and Ted reference! Seriously, though, thanks for this. Hubby and I are standing at the edge of the pool, waiting to dip our nervous toes into the stock market, and freaking out about it a bit. This helped lots.

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    1. Hi Laurie! Thanks very much for reading, and I’m so happy that you found it helpful! It can be a little scary stepping into a new world like the stock market for the first time, especially with all the unnecessary noise in the media which can make it feel overwhelming. If you keep things simple, I’m sure your confidence will quickly grow and you’ll find a consistent approach to investing that works for you. Best of luck taking your first steps!

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  9. it is very interesting.. for the average investor their mental 'anchor' is the stocks 52 week high.

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    1. Hi Tom – yeah anchoring to past prices is one of those common behaviours that really doesn’t help our decision making. It is amazing how the peak is often used as a reference point, and how upset people can get when stocks fall from their highs. It can be easy to lose perspective on the bigger picture of how they’re performing in the long run.

      The media do love to focus on this too – like when the market ‘plummets’ 5% from its recent highs, but not mentioning that it might have grown 30% in the previous 12 months…

      Perhaps this has some parallels to the whole ‘hedonic adaptation’ thing, where people quickly grow accustomed to better standards of living, and find it hard to go ‘backwards’ – once stocks hit a new high, that becomes a new expectation for where the price should be.

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  10. I gotta admit, I almost took off to my next standby blogger, but glad I stayed. It's a great post, and though I'm fairly new at it, I'm leaning towards the Bill method and seeing where things go in the next few years.

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    1. Thanks areyagonnaeatthat, I’m really happy you stayed to read! Good luck with testing and developing a method that works for you. Bill’s approach is certainly not a bad starting point – trying to avoid getting sucked in to Ted’s mind-set occasionally can be the challenge!

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  11. Have you been looking at my pasty brokerage statements??

    That's why I just S&P it anymore. and of course, RE. I am looking at some larger apartments now.

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    1. Ha! I think many of us who have invested in stocks have shared a few of Ted’s experiences at some point!

      It sounds like you’ve really found your groove in real estate which is awesome. That’s really the key to all this - finding the right method of investing that suits your own personal style and helps you achieve your goals.

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  12. John Bogle has said several times that you should contribute early and often to your portfolio in the appropriate asset allocation for you, automate that if you can, and then "Don't peek, don't peek, don't peek, don't peek..." He actually had a few more "Don't peeks" than I quoted.

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    1. Hi Bryce! That’s definitely a classic piece of investing wisdom from John Bogle. It’s incredible how hard the ‘don’t peek’ part can be sometimes. With stocks in particular, people seem wired to want to check prices all the time – it seems to give us a little buzz seeing the share price moves up, even if only a few cents. Unfortunately, the feeling we get when we see the price fall by the same amount is usually much worse, so in the long run, peeking doesn’t actually make you feel too good.

      But what’s worse, peeking also increases the chance you’ll get itchy fingers and sell when you probably shouldn’t, or make some other rash decisions.

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  13. What a nice and simple way of giving a valuable lesson about shares. Thanks to Bill and Ted, they made the reading a lot more fun, too! I have always been intrigued by shares but find it hard to understand. If only everything pertaining to investments and shares and stuff were written this way.

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    1. Thanks very much for your comments Jen! I’m glad you found it a fun (and useful) read! Unfortunately there is a lot of material out there that can make it sound more complicated and technical than it needs to be, particularly for those with a genuine long-term focus like most readers here at DB40. Bryce’s quote above from John Bogle is a good example of keeping it simple. I think there’s much greater value to start with in being aware of good behaviours and habits, rather than getting too caught up in the technicalities.

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  14. Thanks for this - I don't know much at all about investing but I'm trying to learn more because when my debts are gone, I intend to invest. This was a really easy way of explaining a little about shares and how the temptation to jump ship can really have an impact on our investments.

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    1. Thanks Hayley! It’s fantastic that you’re already starting to learn more in preparation for investing – a little bit of understanding goes a very long way. Although understanding your own behaviours and the big impact they can have on your investing is just as important. What an amazing feeling it will be once those debts are gone! Good luck!

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  15. I guess the optimum thing is to buy the stock when they are on a bit of a downturn but expecting it to rebound. Trying to find those stocks would be my challenge.

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    1. Hi Debt Debs! Yes that can definitely be a great strategy, as long as you find the rights stocks. If you can identify high quality businesses that are very likely to be around for years or decades to come, then downturns can bring a great opportunity to buy these businesses ‘on sale’. Warren Buffett is a great example of this – particularly because he sticks to businesses he understands. An alternative might be to use the same plan with an index fund, where you don’t have to worry so much about picking or understanding the stocks.

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  16. Great choice on fictional characters, always nice to see a Bill and Ted reference.

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    1. Thanks Even Steven - they've just been so quiet for so long, it's nice to bring them into the spotlight again :)

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  17. Oh, I wish I were Bill. When my investments start depending on the market, the control-freak/worry-wart in me is going to be going crazy. I'll just have to never read a paper or watch the news until I retire.

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    1. Hi femmefrugality! Yes, to be like Bill would be fantastic. If I was trying to emulate Bill, an important step would be to do the work upfront to decide what to invest in for the long-term, such as great quality businesses that are trading for a reasonable price, or index funds. But the fact you’ve recognised some of the challenges you think you’ll have with your own behaviours is a great step towards figuring out how to best manage it! I don’t think turning of the news is such a bad thing in general these days anyway… best of luck with your future investing!

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    2. Great tips! Thank you! And the news is super depressing on all fronts anymore. I try to stay informed, but man...

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