Friday, 12 September 2014

Why pick individual stocks?

From my own observation, people who pick/buy stocks do so for the following 2 reasons
  1. They enjoy either the thrill or promise of  their stocks' prices skyrocketing, and probably can't sit back and do nothing while hearing stories from their friends how well their stocks are doing.
  2. They want to beat the returns of the index.
It is easy to see which group you belong to. If you belong to the 2nd group, you will know the annualised returns of your stock portfolio. Else you probably belong to the 1st group.

One possible index investing scenario
Take for example, an investor who invest 1000 shares in the SPDR STI ETF every 6 months, and he started just before the financial crisis in 2008, which is around May 2008. Thereafter, the index dropped by a whopping 50%.

Taking into accounts of dividends payout (which is not re-invested) and excluding commission charges, the result as of September 12th 2014 is as follows:

Total capital invested$40,730
Portfolio Value + Dividends$51,319

This translates to a 26% in absolute gains or an internal rate of return (IRR) of 10.25% over a 6.5 year period. This is a strategy that even a high school student can execute, just buy the index every six months! No need to read annual reports, examine charts, listen to financial news, stock tips etc, and you can beat the returns of banks interest (0.05%), bonds and inflation rate (~3%).

Spreadsheet of the above calculation available here.

What I am trying to show here is that we should not belittle the returns of index investing. Yes it will be boring and takes a lot of discipline to stick with it (Even I sold of portion of my ETF recently to invest in stocks). But the above result speaks for itself.

Back to the original topic, for those of you who pick stocks, you better be sure that you are beating the returns of the index. Else you are probably "paying expenses" just to enjoy the thrill of stock picking.