10 Investment Myths
Posted: Friday, December 03, 2004
by Sam Lim
Myth: Thailand-oriented funds had just topped the 1-year performance table, so it is a good bet to invest in Thai funds now.
Truth: A fund which had just topped the 1 year table may soon run out of steams. They may rest a while before picking up the heels again. A minimum 3 years time frame should be used to gauge the quantitative performance of a mutual fund. 3-years are long enough for the characteristics of the market to have changed once or twice, allowing the underlying merit of a given fund manager to show through.
Myth: Economy is at the peak of the cycle, with interest rate rising soon, so I should not invest in bond.
Truth: If we adopt a portfolio approach to investment, fixed income asset class such as bond should always have a place in our portfolio. While high quality bonds (investment grade) have an inverse relationship with interest rate, emerging market bonds (non-investment grade) are not so much influenced by interest rate movement. An improvement in economy means better credit rating for the emerging market bonds which translate into higher bond price. By managing the credit and interest rate risk of a bond, a good fund manager is able to generate a decent return for its bond portfolio in a booming economy.
Myth: A person approaching retirement age should not include risky asset such as equity in the retirement portfolio.
Truth: Our retirement lifespan may last 15 to 20 years if we retire at age 60. Such a long retirement period means that we need to have equity asset in our retirement portfolio to provide us with the required returns to keep pace with inflation.
Myth: Equity fund A is more attractive than fund B because its potential return is 10% which is higher than B’s 8%.
Truth: The attractiveness of a fund is not based on its expected returns alone. We need to know the risk taken to acquire the desired returns. In other words, return on a risk-adjusted basis is a more appropriate benchmark for comparison.
Myth: Capital guaranteed fund is a good investment since we will not "lose money".
Truth: While it is true that 100% capital guaranteed fund will return our investment capital if the unit price falls below its initial offer price at maturity, but we will be losing on opportunity cost if that scenario comes true. The opportunity cost can be the guaranteed return one stands to gain if you leave your capital with the CPF board for those investing with their CPF savings. Because of inflation, you will also be "losing money" if you get back only your capital after 3 to 10 years.
Myth: Unit trust investment is for the long term.
Truth: Yes, we should take a long term view when comes to investment. But that does not mean we should invest in a particular fund and then ignore it until 10 or 20 years later. One should be more proactive in managing one’s investment portfolio. Investment in the market fluctuates everyday. Over time, the asset mix of your portfolio may shift from your initial desired strategic asset allocation. Not rebalancing your portfolio may subject you to risk you are not prepared to take. Take profit on those funds which have grown and plough it back to those which had fallen if the fund’s fundamentals remain intact.
Myth: A listed company’s earning is growing at a compound rate of 10% for the past three financial years seems like a good investment with its low trading P/E ratio.
Truth: The growth rate (10%) is the workings of the compounding interest and retained earning. A better valuation ratio is the return on equity (ROE) which shows the efficiency of a company in the deployment of its equity and debt capital. If the company maintains the same ROE for the past 3 financial years, it is not really an efficient company though its earning is growing at 10% per annum.
Myth: Stock A is trading at $0.30, so is "cheaper" than stock B with its market price of $1.00.
Truth: A stock’s value should be measured relative to its earning growth potential. If stock A’s forecasted earning is $0.10 per share, its P/E will be 3. Stock B’s earning, on the other hand, is projected to grow to $0.50 per share which translate to a P/E of 2. Obviously, stock B is a better investment choice, giving its higher earnings growth prospect.
Myth: The U.S market is experiencing a downwards trend because of the series of interest rate hike introduced by the Fed to cool the overheating economy. Fearing that other economies will be affected, we should avoid investing in all equity markets.
Truth: With the exception of export-oriented economies who depend heavily on the U.S market, other economies who are less dependent on U.S or have large domestic market should still be attractive to investors. In other words, each economy should be judged on its own merit. Not all economies are created the same. This is especially true now where the Asian markets are beginning to decouple itself from the U.S stock market.
Myth: I know nothing about investments, so I leave everything to the professional, such as my financial planner.
Truth: We can leave the intricacy of investments to the professional, but we must never "wash our hands" off it after handing over the money. It is a good habit to find out more about a specific recommended investment before committing our hard-earned savings. The rule of thumb is "never invest in something that you have difficulty understanding". And remember when something is too good to be true, it probably is.
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