The Ten Commandments, Redux

This is seriously too funny not to share.

A bunch of Christians have gathered at the famous golden bull statue outside of the NYSE to pray for economic recovery. Except that I am pretty sure the Ten Commandments have something against this exact situation.

No, really. Golden. Bull. Praying. I'm expecting Charlton Heston to walk out of the NYSE Building any minute bearing clay tablets.

Here's the video.



(HT: Zach, who linked me to Wonkette.)

Zinger

"First, all the countries that got access to the Fed’s swap lines are US allies, and all except Singapore are democracies. Russia may be part of the G-8 but it is outside of this club."

- Brat Setser, "At this rate the world's economy will be remade before November 15th".

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The article is not about Singapore of course. I am amused, however, at how off-the-cuff the reference to Singapore not being a democracy is. There is also a remark that Singapore is considered a developing economy.

The article is pretty good though in highlighting that our traditional understanding of the global economy will shift fundamentally. The IMF has already moved in ways that are considered deeply non-traditional, economies like Singapore, Korea and Brazil are getting swaps at terms similar to G-10 countries, etc.

My 0.02 prediction will be that the focus of the world economy will eventually become more mulilateral, which is a good thing by my books. Perhaps it will finally drive home the fact that our global economy is truly global now.

The Minibonds Continued

I've been reading some comments on Tan Kin Lian's blog post, here and here.

Some of the points that I have raised in my post have been addressed by the various commentators on Tan Kin Lian's blog. To summarise, the points are:

1. That the Minibonds were marketed in a way that did not fully disclose their risks; and
2. That the differences in interest rates between fixed deposits and minibonds were so small that no sane person would have taken the risk of credit default just to get that extra returns if the risk had been properly disclosed.

I have two responses: hindsight bias, wilful ignorance and self-serving bias.

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Yes, I agree that there is some level of misselling involved in the Minibonds. However, I also think that there is some level of misselling involved in EVERY structured financial product out there. What makes the Minibonds so special?

I think that the differences in interest rates between fixed deposits and Minibonds is a fair argument, but one that is ultimately tainted by hindsight bias. Essentially, the argument is that investors who sought a safe investment invested in this product because they thought Minibonds were safe. And now that they are proven not to be safe, they want their money back.

The problem is, back in 2006 - 2007, Minibonds WERE thought to be safe. No one who bought the Minibonds back in 2006 - 2007 that Lehman Brothers would go under.

My question here is this: Did you really think that the increase in returns for the Minibonds as compared to the FD would come for free? If you didn't, then congrats, you made an error of judgment, and have no one to blame but yourself, but at least you have the moral courage to admit to yourself that you took increased risk for increased returns.

However, if you thought that you essentially got a free lunch, then it would probably be because you thought the credit event would never happen. Except it did. And you cannot possibily be in the wrong because, well, you're not.

Except that you are. Because what you are doing is looking at the investment with the benefit of hindsight, realizing that the investment were not as safe as YOU THOUGHT THEY WERE, and grasping for every bit of wrongdoing available to absolve you from responsibility of your bad decision.

THAT is why I don't think the Minibond investors should have any more compensation than any other sort of investor - because they made the same error of judgment that everyone else made in the market, but they are getting absolved from their responsibility without admitting any errors on their own part.

That makes me sick.

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The second issue here is why I draw a distinction between Uncles and Aunties asking for their money back and every other investor. Uncles and Aunties have no capability of finding out what their risk profile is, while the average investor (presumably fairly well-educated) does.

The question is not whether the investors know about their risk profile. The question is whether they have the means to find out.

In the former case, the Uncles and Aunties don't. They are fully reliant on the banking-sales-persons to tell them what exactly their investment entails. In this case, the misselling involved has an aggravated effect, and it would be just and fair to compensate these people.

In the latter case, what we have is wilful ignorance. They have the option of finding out more about their investment instead of listening to everything their salesman tells them. Had this been a sports car rather than a financial product I suspect that this would exactly have been the case. Except it wasn't.

The sole concession I will make is that prospectuses aren't the most legible of disclosure tools. Still, a basic principle applies - if you don't understand it, why did you invest in it? You wouldn't do that for a car, or a house or any other major purchase in your life.

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Given these two factors, I will bring on my third point - that it is entirely possible that your average investor believes himself to be an innocent victim, even though he is not.

The problem here is that it is very human to intepret an ambigious situation to your advantage. As argued before, the situation is VERY ambigious. The banks are at fault, the individual bankers are at fault, the institution is at fault, and the individual investor is also at fault.

I believe that is what is happening in this situation: everyone is pointing fingers at everyone else EXCEPT themselves, in hopes that in the confusion, someone will relieve them of the burden of their bad decision.

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I do not believe these to be theoratical factors by far - I've argued these points from a very human perspective. I think talking to individual investors for the Minibonds saga is a surefire way of losing objectivity in this exercise - everyone is a victim in their own mind.

IF you want to be objective about this whole exercise, ask the important question - why are Minibond investors getting compensated while the buyers of other structured financial crap is getting diddly squat?

The Minibonds Issue

Warning: This post will contain unkind language and unkind generalisations. I make these generalisations because they are, by-and-large, true. Please do not email me with stories about how Singaporeans / Bloggers / Government / Bankers aren't actually like that. I'm not fucking interested.

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I've been following Singapore Daily for coverage on the Minibonds issue. I'm annoyed as hell because the coverage is basically:

1. The Government must do something!
2. The Government sucks because they are following what everyone else did!
3. Tan Kin Lian rawks!

I have no issue with praise for Tan Kin Lian. He did a good deed in the middle of a crisis, and should be commended.

I have a huge issue with the rest because, as always, it's myopic at best, an outright shirking of responsibility at worst.

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Let me start with this basic principle.

The Government owes you nothing, because they weren't the ones stupid enough to buy the bonds, you were. This basic principle holds unless you can show wrongdoing, which I will get to in a minute. For summary, this is directed not at the Uncles and Aunties that lost their life savings because of mis-selling. I'm directing this to your average greedy, ignorant Singaporean that wants easy riches but doesn't want to do the work to earn it.

Face it: you got screwed over because you were greedy and ignorant. You, the moron who didn't do basic research, who got swayed by snazzy salesmanship and aggressive selling. This information was available on the internet 2 years ago. Caveat fucking emptor.

You're the one that's getting a free ride out of this. You're riding on the coattails on sympathy for Uncle and Auntie to get bailed out of a bad decision. You don't deserve spit, let alone sympathy.

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To the bankers who sold this pile of junk - grow a spine and some balls and face up to the fact that you've rogered the pooch. About the only thing I'm happy about here is that you're now past the lawyer as the most hated profession in the world.

Learn the phrase product-driven sales and what it means. That means answering my mother's question about what happens in a Credit Event. Don't slink away, say "I don't know" and never return my mother's call. It's your job to know. Do your job.

(Full Disclosure: My mother refused to buy minibonds because the banker couldn't answer her question.)

One more thing: Don't give me bullshit about your commissions, incentives and pay structure. I know that your job is essentially a sales job, and like all sales jobs, they are primarily commission based. I also know that whenever a commission in on the line, all bets are off, so chances are, I believe that you did missell to Uncles and Aunties, because your commission is on the line.

Don't give me bullshit about industry pressure. You can always find another one. The fact is, you're probably in this line because you thought it would make you the most money. The fact that the banking sales culture is fucked up doesn't mean you have to be. That argument didn't work too well for the Nazi's either. (And a massive HT to Godwin's Law!)

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To the employers of these bankers, guess what? You screwed up too!

Look at that incentive structure of yours. Go on, take a good hard look at it and tell me you didn't design it to maximise sales while paying lip service to whatever corporate governance structure your lawyers / accountants / consultants slapped together to make the absolute minimum requirements required by law and commerce. I dare you.

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Government, you're not off the hook either.

You failed too. You failed in the basic fundamental principle of government, and you failed it because you've lost credibility.

You see, when you decided to unliaterally impose your massive pay raises, you were basically setting yourself up for failure. You can't live up to those expectations you've set for us in justifying those pay packages. No one can. Don't even bother trying because you will fail and look stupid for it.

The fact is, everything that has happened since then, from electricity hikes to Mas Selamat to Melamine is being blamed on you because you have set yourselves up as infallible leaders. It doesn't matter if you can't control these events. The fact is, Singaporeans will take every opportunity to strike out at you because you've set yourself up to be struck at. That is why Singaporeans will never be satisfied with what you do, because you've set yourself up so high that even you can't live up to those expectations.

I understand the fact that these pay packages are more to encourage the next generation of leaders to rise up rather than to benefit yourselves. Just because I understand it tournament theory doesn't mean everyone does.

How does it relate to this situation? Doing nothing and studying the situation may have been the best option, but you don't have that option because you've lost credibility. You've lost the faith of the people that you will do what is in their best interests. EVERYTHING you do now will be interpreted as a callous action designed to take money from their pockets and put it into yours. You have no buffer of good faith left, no emotional bank account to draw on.

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Now that I have ranted enough, I will give you my take on this situation.

On a practical level, Tan Kin Lian is right. The reason why the government will be drawn into any large scale issue like this is because, quite frankly, our access to the justice system sucks. There's no class-action mechanism, nor is there a contingency fee arrangement of any sort. Say what you want, but a combination of these two -is- necessary for large scale dispute resolution of this sort.

On this basis, what I suggest would be the best action for the government to do would be to set up some kind of expedited, collective arbitration process for this. Appoint a couple of independent arbitrators, a couple of counsel on either side, and let this thing play out.

The reason I'm suggesting this is because I don't want to see free-riders in the equation. I'm happy to restore Uncle and Auntie's money IF the sales tactics used on them were reprehensible (and I'm almost sure that at least some of them were). I'm not happy to see a greedy, ignorant Singaporean being relieved of the consequences of his decision.

This also has the added advantage of a possible scouting ground for future leaders. This sort of thing isn't easy to organise. It requires some level of community grassroots experience, or financial know-how, or legal know-how, plus a healthy level of community spirit (or sheer ego) all of which are shoe-ins for future leaders of Singapore.

My 0.02, as usual.

Diversification, Costs and Dollar-Cost Averaging

This is the last instalment of my finance series.

So you want to invest in the stock market. The question is, what sort of stocks should you invest in? I've alluded to the issue of having to keep your investments locked for a fairly long period of time if you want to minimise the volatility of your investments. Unfortunately, companies come and companies go. Who even remembers Broderbund, or American Locomotive, or TSR, just to name a few? At times, even entire industries become defunct. Locomotives, steamships, ice-trawlers, all of these technologies have been surpassed by newer, better inventions. Yet, there was a time where these were considered safe investments.

So how do you know if a company is a good investment for the next couple of decades? You don't. You just need to diversify.

To use a simplistic example, when the price of oil goes up, oil companies do well, transport companies do badly. The reverse is true. Obviously, the solution is not to time your investments according to the price of oil (which is speculation and speculation is bad). The solution would be to invest in both, so that your investment becomes effectively immune to the volatile prices of oil.

Taken to the logical extreme, you would need to invest in a company of every type there is in the world in order to get true diversity. Is that even possible? Fortunately, there are shortcuts around this, and this is where I bring in index-investing and my rant a month ago.

An index is essentially a composite of the biggest movers and shakers in a certain stock market. The much-cited but often-misunderstood S&P 500 is an example. The short version - the S&P 500 is a composite of the stock prices of the 500 biggest companies in the United States, accounting for 80% of all the money that is raised through the NYSE and NASDAQ. It is safe to say that whatever happens to the S&P 500 index is indicative of the entire NYSE and NASDAQ, which is why it is usually cited as an quickie way of indicating a certain country's stock market performance. Other indices include the Nikkei (for Japan), the Hang Seng (for Hong Kong) and the STI (for Singapore). There exist funds out there that allow you to invest in these indices as a whole. The Vanguard S&P 500 is considered the god-king of all index funds, and if you have the means and ability to invest in this, this is definitely an option.

As you can see, index investing allows you to diversify quite simply. It does not offer true diversification, because each index usually covers only one country and certain factors can affect entire countries while leaving others intact, but it does make your job a lot simplier. My personal opinion is that economies are now so inter-connected that if you invest in a developed index, the general movements will be about the same. This graph tracking the S&P 500 and the STI sort of makes my point, though I note that the tracking is most true after 1996.

I've alluded to another investment vehicle in my earlier post - the iShares S&P 500 which is pretty much the same thing, though brokerage commissions makes this cost prohibitive for any single investment below 10k.

Which brings me to my next point of investing - cost.

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Every "movement" in your investment incurs cost. Buying and selling shares involve brokerage commissions of 0.28% for discount brokerages in Singapore, or $25, whichever is less. Clearly, then, the cost of investment is prohibitive unless you can accumulate $10k to invest at a time.

Your other options are funds. Funds have their own problems. Usually, funds in Singapore allow you to put in small sums in every month, BUT, they charge you much larger ratios for this privelege. We're talking anywhere from 2 - 5 % upfront, and anywhere from 1 - 1.75% every year you keep the money in the fund. So yes, this is not an optimal solution either.

The cost of investment in Singapore is one of the reasons I wrote about my frustration over investing in Singapore all those months back. Your options are basically (i) invest in a fund, get ripped off (ii) invest in shares yourself, but only once everytime you accumulate 10k worth of cash or (iii) invest in a foreign fund, and get charged for overseas custodial fees (the fees the brokerage charges for keeping foreign shares on your behalf).

It would appear that (ii) is the best option, and in a lot of ways, it is. There is however, one catch to that.

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My final point of investing is dollar-cost averaging. I spoke in my previous post about investing early and often. One reason is the "head-fake" I wrote about. The other is actually average out your costs of shares over the long term to overcome volatile stock prices.

Dollar-cost averaging is a simple concept. Every month you put aside some savings, say $1000. Every month, you sock this money away into a fund, or shares, whichever you prefer, and buy whatever amount of shares you can afford with this sum. This way, you average out the cost of shares over a long period of time, and you will get a roughly smooth progression of the price of shares without the volatility affecting it.

The issue with option (ii) above is that most people will take a long time to accumulate $10k. This tends to screw around with dollar cost averaging a little. The fewer times you invest, the more volatilty will affect you.

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As with all things in life, there is no perfect solution. Each investment is a series of trade-offs you must make. However, if you reach the point where you can consider the trade-offs in your investment strategy, you're probably on the right track, and have avoided most of the major mistakes in investing.

Good luck, Pendragon. I've taught you as much as I can summarise in four posts. There's a lot more to learn, but the basics are mostly here. As with swordsmanship, there are things that definitely don't work, but even among the things that work, you have a choice. Take what you've learnt, make those choices, and turn this knowledge into your own.

Why Invest?

With all my cautionary tales about the stock market, it's a wonder that anyone even bothers to invest, much less in the stock market. Why bother, when a long term savings or FD is practically riskless and gives a steady return?

Here's the reason: you invest because over time, all other things being equal, your money is worth less.

We've all heard about inflation, that 3-5% per annum force of economic nature. Simply put, your money buys 3-5% less every year, year on year. In most situations, you're better off just buying whatever you want now, as opposed to next year, or over 25 years. Unfortunately, if you want to save your money for a future purchase, that money's going to be worth a lot less over time.

Compare. An FD or long term savings account gives you 1.5 - 2% per annum interest. Average inflation is about 3 - 5 %. That means you lose 1% on a good year, 3.5% on a bad year. That's slow death.

So why invest in a stock market? Because it pays the best over the long term.

The key here is to recognise that there is no free lunch. Whenever you choose a vehicle to invest in, you are taking a cost-benefit analysis of risk versus returns.

Think about it this way. FD's and long term savings plans pay low interest precisely because there are so many protections in place to ensure that the savings do not suddenly disappear. For example, banks are required by law to keep a certain sum of money available to support withdrawals from bank accounts. Even if the bank goes belly-up, you will get something back.

Stocks are different. Stocks represent ownership of a small piece of the company. If a company goes belly-up, you can be almost sure that you lose the money you invested, with nothing back. The upside is that when the company makes money, you make money too.

The second thing about stocks are that they are volatile like crazy over the short term. By volatile, I mean their prices generally fluctuate over a large range. Again, compare this to FD's. The returns of an FD general fluctuates between decimal places of a percentage point. The returns of stocks can be large gains OR large losses. Generally, volatility causes more people to lose money than gain it, because people tend to do things to avoid loss rather than consolidate gains. In other words, people tend to panic sell more when stock prices are low, but hold on to shares much longer than necessary to maximise their gains (another argument against short term investing).

However, it's a fairly well-known fact that over a long period of time, stocks outperform almost every other form of investment. We're talking anywhere from 7 - 15 % over the long term, year on year, and depending on your stock investment strategy. If you remember the inflation rates, that's almost 4 - 10% over inflation.

The implications of stock investing are as follows:

1. Don't invest what you can't afford to lose in the stock market.
2. Be honest with yourself about whether you can really afford to lose this sum
3. Build a long term strategy for stock investment and stick to it. This is a "head-fake" to get your panic-sell and over-holding reflexes under control.
4. Make sure it's a LONG TERM strategy. Hold those stocks for at least 15 years. That's the minimum amount of time you'll take to see long term gains on your stocks.
5. Because you need to hold those stocks for such a long time, create an investment strategy that involves companies that will be around for the next 15 years or so.

That's the basic strategy for investing in the stock market. In future weeks I will be writing about my favourite fire-and-forget solution to investing in the stock market as a whole.