Monday, 26 September 2016
"Bei kambing" passive index investors - Part 1 of 2
I love to watch documentaries.
For many years, I've always believed gravity is pulling us down to Earth - the Newtonian and main stream view that the common man in the street knows and accepts as "correct".
What do you know?
After watching documentaries on Einstein and his General Theory of Relativity, I've learnt that its in fact the curvature of space-time above us that's pushing us down to Earth...
Of course those of you who studied Physics at tertiary level would already know. Maybe.
Bei Kambing understanding versus Erudite understanding
The same gravity example can also apply to Low Cost Passive Indexing.
If you look around our blogging community and forums, you can spot these 2 different creatures.
One just have a single STI ETF (single country focus) and that's that; the other usually have several ETFs that include more than one asset class, and covers either globally or at the very least covers one large regional geographic area.
I rather not point these bloggers out as its better you discover them yourselves.
Low cost is just one part of a Passive Indexing Strategy
If we buy unit trusts from a bank, the usual commission is 5% - unless there's a promotion.
The same unit trust can be easily bought at 1 to 2% commission through on-line unit trust distributors - depending on your order size. Sometimes there are even no-load zero commission offers!
How?
If I buy online can my actively managed unit trust be considered "low cost" now?
What?
The annual management fees are more expensive for actively managed unit trusts than ETFs.
So that tiny 1 to 2% makes a lot of difference?
Of course it does! It we compound it by 20 to 30 years. Fully agree with you!
Now it's my turn to ask you some questions...
On an intraday level, did you notice there can be a 1-2% difference between the daily high and daily low for the ETF quoted price?
So 2 person buying the same ETF on the same day can receive 2 totally different entry prices with difference ranging between 1-2%, can we agree on that?
You know what's coming... Wink.
2 person who do dollar cost averaging on a monthly basis can have a 5% difference in entry prices if one bought on 1st of June and the other 30th of June. Possible right?
And if the same 2 person passively dollar cost average into a ETF annually, the differences in entry prices can actually be more than 10%!
Is it fair to say the "unlucky" passive dollar cost averaging person as "high cost"; while the "lucky" person as "low cost"?
Try compounding the differences for the next 20-30 years... Yeeks!
You tell me, does the tiny 1-2% difference in management fees between actively managed unit trust and ETFs still such a big deal?
P.S. In part 2, I'll demonstrate why buying a STI ETF is an active decision; and this decision has a even bigger impact 20-30 years going forward than low costs...
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SMOL,
ReplyDeleteLow cost doesn't mean low price right? The unlucky one will be the one buying into high cost at high price.
In term of dollar cost averaging, there is the law of large number. If we want to ensure that we don't overpay and the price we pay is closer to average, do we buy one shot or do we spread our purchase? If we spread our entries, what's the optimum purchase size to minimize each transaction cost? All the answers will determine what's the size of each purchase and how frequent (one time, every week, every month, every quarter, every 6 months, every year, etc)? I personally prefer value cost averaging than dollar cost averaging.
Yaruzi,
DeleteI've given a little teaser to those "bei kambings" who never spent time reflecting what sort of entry process would be most optimum for themselves.
One time lump sum or spreading over daily, weekly, monthly, annually; etc.
Sometimes what we believe or were being told can be different from reality:
Is Dollar-Cost Averaging Overrated?
Ironic isn't it?
I wonder how many have researched on their entry process for passive indexing?
You obviously have done yours as opposed to those who adopt a "Look ma! Nno brains needed!" approach...
LOL!
Hi SMOL,
ReplyDeleteI think you are also referring to this comic strip right?
http://www.valueinvestasia.com/wp-content/uploads/2014/05/34812-strip.gif
Unintelligent Nerd,
Delete1. You take your cartoon and put it side by side with my "Is Dollar-Cost Averaging Overrated" link with Yaruzi.
What do you think?
2) If putting all our eggs in one basket is risky, will putting our eggs in 3,000 baskets be better than 30 baskets?
Hmm...
LOL!
1). Passive index investing is not a sure huat strategy. When you think deeply and multiply your variables (e.g. entry point) with other variables (e.g. the different sector weightage in the index), consistent annualized 8% returns that "investing textbooks" usually teach are not what they seem to be.
Delete2). Uh....we have to see the different sector weightage in the index bah.
As a bei kambing myself, I think I know what's the problem. I do not have the tools to evaluate what is said in the "textbooks" of investing. The easy way out is "Experts say this. Okay lor, I believe!"
Even if I think of tools to evaluate the assertions of gurus, I will question myself whether are these tools fit for purpose..... :/
(Anyway have to thank you again. Whenever I read your posts, I always push myself to question my assumptions)
Unintelligent Nerd,
DeleteYou can already run faster than the next hunter. We don't always have to outrun the bear ;)
Since I not that smart, I practice Learn by Doing.
This song dedication for you:
Try Everything
I always have a wry smile when "intelligent" people make opinions on matters they have not tried themselves.
How did you come to this conclusion?
Oh! Who and who said so!
Ah! A parrot.
P.S. I trade unit trusts and ETFs ;)
Nice song. Eh? From Zootopia. Nice movie.
DeleteLol. "Intelligent" people always think their expertise is transferable from one domain to another. Well, that is true for some subjects, but not for everything.
That's why you see Nassim Nicholas Taleb go suan all the academics. XD
:)
DeleteThe market fluctuates every second and so do the prices of the ETFs. Good ETFs follow their index very closely and only have a small tracking error. When buying a few times a year the error will normally even out.
ReplyDeleteWhenever you buy into an active fund or unit trust you will be susceptible to market fluctuations as well, except that you do not get to experience them first hand, but the fund manager will.
maru,
DeleteETFs are great as trading vehicles since we can know exactly what price we are selling or buying intraday - as opposed to unit trusts.
You have brought up a good point about tracking errors.
My example is not about tracking errors.
2 person buying into the SAME Nikko STI ETF, it is possible - even if we dollar cost average it daily - to have 2 different aggregate entry prices at the end of the year right?
The differences will be more pronounced if we dollar cost average from daily to weekly, from weekly to monthly, and monthly to annually...
Just showing if you are "unlucky" with your passively automatic entries, you could be still paying a lot more in "slippage".
And if we add Yaruzi's Value Dollar Approach and the more "statistically superior" Lump Sum approach, how?
Now we know why there's so many denominations with some faiths...
Same Heaven and Earth; different shepherds.
Hmmm
ReplyDeleteI only know some may end up dollar average on high side, some on low side. Depends on how long.
Small Time Investor,
DeleteThat's just the entry process. I've deliberately held back on the exit process for my Part 3 post focusing on unit trusts ;)
Hi Jared,
ReplyDeletewhat you describe can/will happen to an investor into unit trusts and individual stocks too.
We never know whether we 'optimized' our entry. Only in hindsight.
We have no control over buying at the best price. But we do have control over choosing an investment vehicle that is cost efficient. The 1 to 2% higher annual management fees for Unit Trusts will happen. Not "if" just "when". And yes that is a big deal for the long term investor (not so much for traders like you).
Let me be the parrot here: "Passive, systematic, repeatable investment strategies are the best option for the majority of investors. A small number of active managers can and do outperform the markets. You just have a higher probability of success with index funds and ETFs than you do by trying to choose the small number of active funds that consistently outperform."
The best investors always think in terms of probabilities.
And by the way, entry is one of the least important factors for long-term investors. It's what you do / don't do after you have invested in something that will make all the difference in the long run. And that is totally controlled by our emotions.
Andy,
DeleteAgree with you that only with hindsight we'll know whether our entries are optimised.
This "foreplay" post is to illustrate if you are "unlucky" with your entries in ETFs, you cost of entries may not be that much better than unit trusts ;)
Low cost could turned out to be an "illusion" or emotional crutch...
Cost is important. Do doubt about it. But whether in investing or operating a business, revenues always come first ;)
Hence my last paragraph to stay tuned for part 2 where the decision WHICH ETF to buy has a bigger impact on our LONG term returns than our entries.
Although I must say I was tickled pink to find there's research to that points out a Lump Sum entry works better than Dollar Cost Average?
That's so counter-intuitive... LOL!
Ah! The power of verification ;)
My view is simple actually. Low cost is just one part of a Passive Indexing Strategy - true! While there are many factors not within my control, what I can do is to control those that I can, one of which is choosing low cost. How market will behave is sadly not within my control :(
ReplyDeleteEntry strategy, haha that's another story altogether. Ok ok, for those of you all who don't counter-verify, I help you. I don't know about whether others thought about it, but my train of thought is along what the Vanguard report stated. If you want the "average" outcome, okies, whatever that floats your boat :P
"Even though LSI’s average outperformance and risk-adjusted returns have been greater than those of DCA, risk-averse investors may be less concerned about AVERAGES than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline."
Can't wait for your part 2! But eh, trick question ah? Choosing index investing is an active decision. The ETF methodology is the part that is passive, no? Ah. Come to think of it, I haven't really called myself a passive investor. I should verify too!
Kevin,
DeleteOur ships sail together ;)
The two processes of entries and exits are basically what we can control.
That's why I often poke "investors" who set goals on consequential outcomes they have no control over... At best its influence; and that's about it.
I set goals on improving my entries and exits ;)
Opps! I think I may have oversold part 2. Must dial back expectations.
It's better to under promise and over deliver.
LOL!
Akan datang.
temperament,
ReplyDeleteThat's only half the story...
In retail, we say, "A merchandise well bought is a merchandise well sold."
The trouble with sexy platitudes is that if we don't match it with common sense and personal experience, its at best a "sugar rush" - we say it to feel good and then we feel down...
It's not how much you have won INSIDE the casino, what matters is how much winnings you take with you when walk OUT of the casino.
Any Wilmar retail shareholders here? Wished you have SOLD like Peter Lim when the going was good right?
In sales, the sale is not completed until the customer pays up ;)
I think its not a fair comparison. Granted that your entry price can be higher by a few percentage points, but thats a one-off cost. Compare this to an annual mamagement fee of 2percent. The latter is recurring. I rather pay 2% more in purchasing cost at the start, than to pay 2% more in annual fees every year. One-off vs recurring, very different.
ReplyDeleteFurther, management fees are calculated based on the TOTAL value of your portfolio; transaction cost is based on the value of that particular transaction. This is a small but extremely important difference.
F4FF,
DeleteI thought I was pretty clear on the issue of annual management fees between ETFs and unit trusts, ETFs win hands down:
"So that tiny 1 to 2% makes a lot of difference?
Of course it does! It we compound it by 20 to 30 years. Fully agree with you!"
What I am showing is 2 ETF investors investing in the SAME ETF may have quite different entry costs if they buy on different time of the day, different day of the month, and different month of the year ;)
If ETF investor A got in at 5% higher entry prices than ETF investor B, there's goes the so called annual management fee savings...
;)
Anyway, costs won't be the main factor (save more).
Which ETF you choose in my view may matter more (earn more). Hope to have your feedback on part 2!