Learn about how to choose between stock-picking and choosing funds for those who have just started their investment journey
The stock market can be overwhelming for the uninitiated, with cryptic acronyms, ticker symbols and financial jargon. How should someone who is starting to invest consider all of the various choices available? And how should they approach one of the first big decisions when it comes to investing: single stocks vs diversified funds?
0:00 - Introduction
6:00 - Stock-picking basics
10:20 - Pros and cons of investing in single stocks
16:46 - Common mistakes in investing
28:25 - Pros and cons of investing in active vs passive funds
35:14 - Fund selection at Endowus
39:49 - How to choose the right funds
45:26 - Time in the market vs timing the market
53:25 - QnA
Excerpts from the webinar
Stock pickers investment approach (6:00)
Sheng Shi: Stock-picking investors assume that the markets are inefficient, so they try to analyse companies to identify mispricing within the market. This helps them buy stocks of companies that are undervalued, or sell stocks of companies that are overpriced. They also try to buy stocks of companies that they are familiar with. This is what Warren Buffett advocates — the more you understand a business, the better it is for you to invest in it, and the more likely you stay properly invested in it.
One of the common strategies employed by stock picking investors is fundamental analysis, where they look at current and historical PE ratio, dividend payout, price to book ratio, or even do financial modelling to ascertain the “right” price. The challenge to this strategy is that these analyses are not straightforward. Industry nuances and macroeconomic changes can affect the reliability and usefulness of the analysis you are doing.
Another common strategy is to use technical analysis, but this strategy has even more limitations, as investors are likely to see “random” returns based on their analysis. Such a strategy is also unlikely to last over the long term due to reasons such as high frequency traders spotting and exploiting these inefficiencies faster..
Pros and cons of investing in single stocks (10:20)
Kelvin: One of the pros of investing in a single stock is that it is easier to get a higher return as compared to investing in funds. But naturally, if you are not experienced in investing or stock-picking, the risk is much higher as compared to investing in funds.
The fees of investing in single stocks are also much lower as compared to investing with a roboadvisor or in a fund.
Sheng Shi: When investing through a brokerage platform, the user interface of the platform actually tries to encourage you to trade more by displaying the market movement. When you become inclined to trade due to these displays, you might actually run the risk of over-trading.
Pros and cons of investing in active vs passive funds (28:25)
Kelvin: Passive funds are like the S&P 500, whereas active funds are like the ARKK ETF where there is someone actively managing the fund. For active funds, the performance of the fund would depend on how good the fund manager is. A study found that 91% of active funds actually underperform the S&P 500. On top of that, they are charging a much higher fee compared to a passive fund. So if you do choose to invest in an active fund, it is very important to choose a good fund manager, instead of just looking at the fund itself.
On the other hand, passive funds track the market and give the same return as the market. Examples would be the STI ETF, or the S&P 500. Since the fund is passive, its fees is also very low — for some funds, the fees can actually be less than 0.1%.
Sheng Shi: It is very difficult to outperform the market consistently, and many studies have ascertained this.
When you look at a longer investment period of 5 years, only 26% of funds managed to beat the market and remain in the top quartile. And over an even longer period of time, only 14% of funds manage to stay in the top quartile. Most funds are also unable to outperform the market due to the high fees they charge.
However, this is not to say all active funds are not worth investing in. For sectors like emerging markets and fixed income markets, around 50% of funds are able to outperform the market over 5 years. When investing in active funds, all investors should only invest in cost efficient funds as cost can significantly eat into your returns.
How to choose the right funds (39:49)
Sheng Shi: Most importantly, you have to understand your investment strategy, desired type of exposure, and investment horizon. Next, you have to decide on whether you want to invest in an active or passive fund.
No matter what fund you choose, do keep in mind that past performance is no guarantee of future results. Having a good understanding of the funds before you invest in them is crucial.