Why Buy Low, Sell High Is The Hardest Thing In Investing And How To Overcome It

This Article was first published on 29th Aug 2018 on our Asia-In-Focus Newsletter. To get the latest newsletters, click here.

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Asia-In-Focus

Aug 2017 Edition

Why Buy Low, Sell High Is The Hardest Thing In Investing And How To Overcome It

Last month, we spoke about the high valuation of the market and my fear that we are heading for a stock market crash or correction. We also discussed the options I have to hedge against that risk. If you have not read our previous email, you can read it here.
I ended up buying an inversed S&P 500 ETF, the ProShares UltraShort S&P 500 ETF (SDS) in particular.

Review On My Decision

Here is a summary of my thoughts.

• ProShares UltraShort S&P500 ETF is a tracking fund that tries to produce 2 times leveraged negative return to the S&P500 index for a single day.
• This means that if the S&P500 index saw a 2% increase on a single day, the ProShare UltraShort S&P500 ETF might produce a (-4%) return.
• This is not ideal because due to the compounding nature of daily returns, the inverse return from the ETF over a longer period might differ from the actual return on the S&P500 Index.
• It still has an expense ratio of 0.9%, which is quite high.
• However, due to the ease of buying, I see it as a better alternative than shorting the S&P500 Index, which has financing cost as well.
• For my portfolio, I see it as buying an insurance. I might waste a few percentage points on my portfolio every year that the stock market continues to rally, but it would help me boost my cash balance if a crisis does hit. That would provide me with more firepower needed to take advantage of the market at the best possible time; when others are fearful.

You might ask, “But wait a minute!”. If we are supposed to be happy and buying during a market crash, why am I so worried about it? Shouldn’t I be selling everything and patiently wait for that magical day of the market crash? After all, the market is about “buying low and selling high”.

I would like to spend some time discussing this topic today. Buying low and selling high sound wonderful in theory. Unfortunately, it is much more complicated in practice.

What Is High And What Is Low?

Firstly, to state the obvious, we never truly know when the market is low or high. In the end, our view on whether the market is high or low is just our subjective opinion, which means we can be wrong. When we invest in an individual stock, we are also expressing our personal opinion on the company, which means there is also a possibility that we will make an error. However, we mitigate that risk of error by diversifying our portfolio. Thus, a few mistakes would not kill our portfolio. Yet, when we take a view on the direction of the market, there is not much way for us to diversify that view. We are either buying or selling, so we would either be right or wrong, there is hardly a middle ground.

Don’t Tell Me How To Feel, Buffett!

Warren Buffett once advised us to be “fearful when others are greedy and greedy when others are fearful”. Many investors like to quote that but not many are able to truly execute that in practice. This is because this advice is not very useful, as it is telling us how we should feel. It might be easy for Buffett to control his emotion. If you have read about Buffett’s life, you know that he is quite an extraordinary person. He has been able to achieve such wealth over the past 80 years because of his amazing investment skill as well as his infamous thriftiness.

Yet, what is most interesting about him is his ability to make extremely logical decisions when it comes to money. For example, he once refused to lend money to his daughter for renovating her kitchen, asking her to go get a bank loan. He also refused to bail out his sister, Doris, when she was close to bankruptcy when they were younger. These showed that Buffett is able to think very logically about things regarding money. He can make his decision completely without emotion.

For the rest of us, controlling an emotion is not an easy task. I am a normal and simple guy, I feel all sorts of emotions when I am investing; ashamed when I made a mistake, angry when luck isn’t on my side, jealous when others are making money but I am not. And have definitely felt fearful when my portfolio dropped 30-40% within a short period of time with no end in sight.

Feel That Fear

If you have never experience that fear, this is how it would creep in. When your portfolio starts to drop 5%, you might feel the excitement, feeling that it is time to get “greedy when others are fearful”. But you are still in a wait-and-see mode. Then your portfolio fell 10%, you feel a little fear but you still want to act in the mantra of being “greedy when others are fearful”, so you start to invest. You might feel a little smarter after you invest, acknowledging that you are one of the few investors that can truly follow the advice of the Oracle of Omaha.

You continue to invest more and more as the market crashes. Now you have dried up all your funds, you are fully invested in the market but the market continues its downward spiral. Another 20% down, 30% down! All you can do is to see your investment decreases in size everyday and getting bombarded by negative news about the stock market. Plus it is not just the percentage losses in your portfolio, you might start noticing the actual amount that you have lost, a few hundred thousand or maybe going into millions if your portfolio is sizable. You start calculating how long it took you to save up that amount. 10 years? 20 years? And would your family notice, what will they say? You start to have this urge to cut your losses and sell out. This becomes an urge that you have to fight off everyday for the next two years.

This is because a market downturn typically would last about two years, this means that it might take about 2 years before your portfolio return to your pre-crisis levels. You might logically know that the market cannot be depressed forever and should recover in the future. Yet emotionally, would you feel no fear at all during that period? I know I was scared. There is always a big difference between what you know logically versus what you feel emotional.

If you think or have felt no fear at all during such a market crash, I congratulate you! You are in the league of Warren Buffett and Charlie Munger! Or… you are just lying to yourself. :p

2 Simple Way To Counter That Fear

So how can we protect ourselves against that fear? A simple trick I used myself is to turn off all information about my portfolio after I have fully invested all my funds during a market downturn. Once I used up all my investable funds, I would not look at my portfolio. I deleted my brokerage, yahoo finance and Bloomberg apps from my phone, I do not read or watch the business news for the next few months. This is because I have already finished up my funds, what good would it do even if I know the market has gotten 20% cheaper? What you do not know, wouldn’t hurt you.

Next, I would find myself a hobby to occupy the time. Because if we are too idle for a long period of time, our minds would start playing tricks on us again. Again, we can do all these for the reason that we know logically in our mind that the market would recover sooner or later. Yet, we have to distract ourselves during that time to prevent our emotions from high-jacking our actions, making us do things that we might regret two years down the road. We not only have to prepare our portfolio for a market crash, we have to prepare our emotions as well.

Know The Real Risk In Investing

Although we talked mainly about the risk we faced during a market crash today, I do believe that a short term risk like a market downturn is not as serious as the main risk we face in investing.
The real risk in investing is the risk of omission. It is the risk of not investing in something even when we know that it is a great investment. It is the risk of not being invested in the market at all.
I made many such mistakes over the past decade, the main one that still haunts me till today is a company called My E.G. Services Bhd(KLSE:MYEG), a company listed on Bursa Malaysia. The company is more and less like a digital Post Office for Malaysia. I invested in the company back in 2011 when it was just trading slightly less than RM0.60 per share. I understand the business and found that it has a huge growth potential ahead of itself. Yet, I was a very strict value investor at that time and would stick to my valuation estimates of a company very rigidly. So when the share price shot up to about RM1.20 per share, I sold off my stake, netting about a 100% gain in two years.

However, fundamentally there is nothing wrong with the company, I sold it merely because I felt it is fully valued. Clearly, the market did not agree with me, the share price continued to rally. After multiple rounds of share splits and bonus issues, the current share price is about RM2.00 per share. From my estimation, I lost out on about 1,400% in additional gain if I have just stuck with this well-run, fast-growing company with a strong economic moat.
It seems my story of omission is not the only one in the investing world. One epic story of the risk of omission came from the famous Richard Li, son of Li Ka-Shing, the billionaire businessman from Hong Kong.

Richard Li made a private investment in Tencent Holdings(700:HKG), the company behind the WeChat and QQ app, back in 1999 at the peak of the dot-com bubble for US$2.2 million. Unfortunately, after the dot-com bubble crash, Richard Li was forced to sell some of his investments in order to save the others. He chose to sell off his stake in Tencent Holdings for US$12.6 million to a South African telecommunication company, Naspers Limited. He made 6 times his investment for a short period of time, that sounded like a great investment right?

Stories tend to have a way to surprise us. Tencent Holdings has become one of the largest technology companies in China and is commonly known as part of the B.A.T. of China; Baidu Inc, Alibaba Group and Tencent Holdings. It turns out, Naspers still owns that stake in Tencent Holdings till today and that original 20% stake could be worth about US$80 billion. If Richard Li has held on to that stake, he could have become the richest man in the world with a possible networth more than 2 times his father today. Do you see how great can the risk of omission be?

Investing Is Risky, Not Investing Is Riskier

Investing is a risky journey, I am not going to lie to you. It is a journey full of surprises, full of worries and full of fears. We will make mistakes along the way, we might lose money from time to time. Yet, not investing at all is even riskier. Inflation is typically growing much faster than the traditional fixed deposit rates in most countries. This means that not investing, we are bound to lose.
On the brighter side, if done RIGHT, investing can be rewarding, deeply satisfying, and wildly liberating. Ironically, if I have not missed the opportunity of My E.G. Services, I would have never been able to identify companies like AirAsia Bhd (KLSE:AIRASIA), ViTrox Corp (KLSE:VITROX), Clear Media Ltd (100:HKG) and Straco Corporation (SGX:S85), which have all been multi-baggers investments over the last few years.

Till we speak again,
Always Moving Forward Together With You.
Regards,

Stanley Lim

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