Tuesday 3 May 2016

[Opinion] What's the point of spending the whole day managing money?

I remember when I first started investing. I read everything I could on Warren Buffet. He was my idol. I also read "One Up On Wall Street" by Peter Lynch. In my opinion, I was armed with knowledge to find hidden gems of the stockmarket. All I needed to do was read every annual report I could find and dissect every company I thought could possibly be a sound investment. What was a sound investment?

Well, by this stage, I had learnt that the value of a company is the discounted value of its future cash flows (known as intrinsic value). A sound investment would be a company that has an intrinsic value well in excess of its quoted share price. "Well in excess" means you have a large enough "Margin of Safety" in case you grossly miscalculated your intrinsic value. Very elegant.

The problem is that finding companies this way takes a long time. A very long time. Most people don't have time to spend their lives analysing every nook and cranny of each investment they may or may not make (i.e. they have day jobs). What is the point of building wealth if you spend every spare second you have working on your portfolio?

The investment approach that requires the least effort is investing in passive index funds. This approach will suit most investors. It is low-cost and requires no monthly monitoring.

The second approach (the one I favour) is the create a portfolio of 20 to 25 income streams by buying shares directly. I write about this approach in "Forget the Noise". In a nutshell, you need to focus on two key metrics; dividend yield and dividend growth. Companies that pay above-average dividends who can grow these dividends ahead of inflation are the source of sustainable income streams.

I also don't trade in and out of these income streams to keep costs as low as possible (in my case they are comparable to index fund fees). This approach is a true long-term approach. Over my working life, I am working on replacing my salary with an income stream provided by investments. This approach also only takes a couple of hours every week. Simple enough.

Lastly, many may say that they outsource their investment management to highly-skilled and competent active managers. I'll be the first to agree that these managers are highly-skilled. Some of them are society's brightest minds. However, most of them cannot consistently deliver superior investment outcomes. They also charge very high fees. You get a double whammy, poor investment performance and high fees. Not an ideal combination.