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High Risk IS High Reward - Here's Why

Updated: Feb 9

And other useful and factual takeaways.

Money Maverick spent some time in Perth last week, trying very much to escape the clown fiesta that is life.

Of course, while he was there - he did come up with Theoretical Applications For How People Can Choose Their Insurance, but apparently that wasn't nearly as exciting a topic as he thought it would be.

...I guess hopefully some insurance-obsessed academic will eventually ask me about it, but eh.

In any case, reading was on the agenda for the trip, and one of the books was 'You Can Be a Stock Market Genius' by Joel GreenBlatt.

It's a pretty old book - but for context, Joel Greenblatt is a fund manager who beat the DOW with returns of 50% a year for over 10 years.

Annualized, not cumulative. On average.

If you've looked at my previous post on aggressive investing, you know that this is no small feat.

What annualized yield do you think this volatility is?

Yes, the annualized yield of this total clown fiesta in the picture is a mere 5.2% annualized a year. (by the way, this is the SNP500.) You can refer to this article below on how absolute returns are more important than annualized, though.


So 10 times THAT isn't something that can be overlooked by anyone on the planet.

For context, let's look at at sum of $100,000 in 10 years.

SNP500 (1998 - 2007. 5.2% annualized): $100,000 becomes $166,018 [+66.018%]

Greenblatt Fund (1985 - 1994. 50% annualized): $100,000 becomes $5,766,503. [+5766.503%]

Almost a 5700% difference, and 5.6 million dollars. Pretty monstrous, so I'm going to sum up the take-aways that mattered to me and hopefully you see how relevant it is to you.


Takeaway 1: The retail investor has many advantages that a Fund Manager may not have

Fund Managers manage millions of dollars, maybe even hundreds of millions of dollars. This applies to both passive and active - your STI ETF, your Robos - they experience the same host of problems.

While there are obvious advantages to institutional investing such as cheaper entry, there comes a whole host of problems such as:

i) Limited strategy imposed by dollar size of portfolio

ii) Legal issues

iii) Fiduciary considerations

iv) Trying not to affect share prices

v) Judged constantly

Most of these are fairly understandable just by looking at the statement alone, but I want to talk about (v) a little bit because a while back, I was discussing with prominent options traders on strategies and returns and why they didn't simply make a business out of their returns, which typically go for 24% or higher year on year.

You have to understand that these are the statistical minorities, very much like the fund managers who succeed in efficient markets like the US. So even after years of learning to be highly adaptable and creating income streams for themselves, most people tend to operate better without the pressure.

If you're a DIY investor who insists on DIY investing, I'd suggest you try not to put too much pressure on yourself or have a lot of people know what you're doing - especially because according to Dalbar studies, you have an even lower probability of doing well.

Much like Financial Planning, set very clear goals for your portfolio - not just because Singtel has a nice dividend - and recognize that not only are you NOT an institution, but it's advantageous not to be like one because you don't have to be accountable to thousands of other people every quarter.

Takeaway 2: Decent Concentration is likely better than Mindless Diversification

Based on past history, the average annual return from investing in the stock market (SNP500) is approximately 10 percent. Statistics say the chance of any year's return falling between -8 and +28 are about 2 out of 3. In statistical talk, the standard deviation is any one year is about 18 percent.*

Obviously, there is still a 1/3 chance of falling outside this range.

What do statistics say if your portfolio is limited to only five securities? The answer, surprisingly, is that your return will fall in a range of -11 to +31 percent. The expected return still remains at 10 percent.

If there are eight stocks, it narrows a little further, to -10% to +30%.

Not a significant difference from owning 500 stocks - in fact, an argument could be even made for having less stocks for a higher annualized return.

Taking a concentrated position beyond that point is advantageous because your higher volatility is likely outweighed by far higher long term returns.

I personally prefer to have concentration in a particular sector or geography with the rest balanced out in some kind of diversification for experienced investors - comfortable 10% annualized, likely significantly higher.

Which brings us to our next point...

Takeaway 3: Don't screw up a perfectly good stock-market strategy by diversifying your way into mediocre returns

Because these articles are fairly technical, I do get some experienced investors looking to diversify.

I've done this quite a bit, although reading this with examples reinforced it - so I'll tell you what I told them: it's important not to think of your investment portfolio as a separate entity from the rest of your life.

Let me try to illustrate what I mean.

So maybe you're a Bogle 3 Fund person [Local Stocks, International Stocks and International Bonds], or a Trident person [Stocks, Bonds, Gold].

Take the Bogle 3 for instance, with a little bit more aggression [80% Stocks, 20% Bonds]

If you have $250,000 - your investment portfolio might look like this.

$100.000 STI ETF. $100,000 IWDA ETF and $50,000 in a Global Bond Fund. Maybe.

What tends to happen is that mot people forget that this portfolio is only a portion of their entire holdings.

Just because these are actively managed by you (to some degree, as you claim responsibility over what happens, selling, rebalancing, etc) does not mean that the other aspects of your life do not fall under this portfolio.

Most people have savings accounts, or their DBS Multiplier. Or CPF.

Or Money Market funds. Their property. Perhaps individual bonds, or bond components like Astrea/SSB, life insurance, etc.

And your actual portfolio suddenly looks like this instead.

$250, 000 - Investment Portfolio [Aggressive, 80 -20]

$100,000 - Cash

$100,000 - Life Insurance

$400,000 - Property

$150,000 - Astrea Bond

The 80 - 20 aggressive portfolio looks a lot more like 20 - 80 now, doesn't it?

In a Million Dollar Portfolio, 40% of that is taken up by your property.

In the entire context, that $200,000 which once held the majority of your portfolio turns out to be too little in what could easily be considered a very, VERY defensive portfolio.

Diversified? Certainly. Safer? Probably.

High Yielding? Almost certainly not.

Re-balancing? Whew.

Takeaway 4: High Risk IS High Reward