June 14, 2009
Lessons from the financial crisis
It is a lot more painful to lose the money already made than not to make it in the first place
By Goh Eng Yeow
China's late paramount leader Deng Xiaoping once said: 'It doesn't matter whether a cat is black or white. A cat that catches mice is a good cat.'
Investors should view the stock market in a similar way: It doesn't matter whether it is a bull or a bear market. As long as one makes money, it is a good market.
Nearly two years into the financial tsunami which caused global stock markets to swing like a yo-yo, it is time to take stock of the lessons which an investor can learn from the crisis.
While these lessons may not help those who lost a big chunk of their wealth during the crisis, it will provide a perspective as to how an investor can learn from the wild market gyrations to invest wisely from here on.
1. Follow the money
I have been an avid tracker of the flow of foreign money in and out of the regional markets.
Time and again, it has proven to be a valuable guide on how the market would behave going forward.
Take late February. The market mood was then at its bleakest and the global protectionism tide seemed unstoppable.
But it was around this time that I reported that foreign money was back in Asia again, pouring about US$1 billion (S$1.46 billion) every week to scoop up badly battered blue chips in the region.
It turned out to be a smart move. Since early March, the Straits Times Index (STI) and Hong Kong's Hang Seng Index has each gained by more than 50 per cent.
But recently, as the fund flow slowed to a trickle, their advances have stalled as well.
2. Cash is king
Never get worked up when you are told that the returns you are getting on your bank deposits are paltry and that you are missing out on a great stock market rally or an excellent investment opportunity.
True, you will never get rich earning 0.25 per cent interest on your POSB savings account a year. But that is no reason for not holding a big sum of cash in case you suddenly find a use for it.
The beauty of cash is that it enables you to pick up investments at rock-bottom prices when everyone else is too cash-strapped to do so.
You can't buy stocks when they have been hammered down to depressed levels unless you have some cash in reserve.
3. The new reality: Wild price swings are normal
There have been many occasions in the past two years when stock prices fell very hard one day - due to some calamitous events in New York or Shanghai - only to bounce back sharply the next day.
The mentality of many traders is to 'fire the trigger now and ask questions later'. This has resulted in horrendous losses as they 'buy high and sell low'.
It takes a lot of courage to be a contrarian investor, nibbling at badly battered blue chips as they come under strong selling pressure from traders fleeing for the exit, but it is a strategy which can be highly profitable.
4. We live in a highly interconnected world
Never look at any stock market in isolation. Billions of dollars have been poured into the region by foreign fund managers who also manage huge investment portfolios in the United States and Europe.
Any decision they make in adjusting their asset allocations will have an impact across all the markets they are invested in.
A chart of the STI over the past two years will show that it has moved in near lock-step with the Hang Seng and Dow Jones Industrial Average.
So, to avoid any pitfall, a wise investor should ideally spread his investments across many asset classes - stocks, bonds, real estate and commodities. What happens on Wall Street and Shanghai will have an impact on Singapore and Hong Kong as well.
5. Beware of investment gimmicks promising high returns
Over the years, I have developed a healthy scepticism about the financial products which fund managers and stockbrokers regularly try to sell to me.
My maxim is that if an investment sounds too good to be true, it will turn out too good to be true. It has always been better to play safe than to be sorry afterwards.
One now-classic example is the notes known as Lehman Minibonds, issued by failed US investment bank Lehman Brothers.
With bank deposit rates sinking to almost zero, investors thought they were parking their funds in a high-yield bond, backed by a triple-A rated bank.
But it turned out to be a very complicated product which had nothing to do with bonds, with a complex trading model that was vulnerable to unusual events, such as the failure of big banks.
6. Avoid unnecessary risks
Young investors have sometimes been told that they can take big risks because they have youth on their side to make good on any losses which they incur in their folly.
Over the years, I have learnt from first-hand experience that this is not true. Investors will tell you that it is a lot more painful to lose the money they have already made, than not to make it in the first place.
Investors should watch their risks carefully and assess what type of reward they are getting for taking such a risk.
To sum up, investors should remember that they are putting their capital at risk when they invest in order to make money.
Legendary investor Warren Buffett once summed it up as follows:
Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.